Measuring Returns Properly
Simple return, annualised return, compounding and total return – how to measure investment results correctly and why +50% followed by −50% isn't break-even.
Key takeaways
- Return is the percentage gain including all income such as dividends and interest, relative to the capital invested.
- Over several years, what counts is the compound annual growth rate (CAGR), not the simple average of yearly returns.
- Losses weigh more than gains – after −50% you need +100% to get back to even.
- Compounding makes time the most important factor in building wealth. The rule of 72 estimates how quickly money doubles.
- Historically, broadly diversified global stocks returned around 5% a year after inflation – with big swings along the way.
“This fund returned 40%.” Over what period? Before or after fees? With or without dividends? Return is the central number in investing, yet it is surprisingly often miscalculated, presented in misleading ways or dressed up. This lesson gives you the tools to calculate returns yourself and to check marketing claims critically.
Simple return
The basic formula is straightforward: how much more do you have at the end than at the start, relative to what you put in?
The income part matters: dividends, interest, distributions. Looking only at price changes systematically understates the return on stocks and bonds. Return including all income is called total return.
Multi-year returns: beware the average
Once several years are involved, there’s a trap. Take a stock that rises 50% in year one and falls 50% in year two. The average of the two yearly returns is 0%. But what happened to your money?
That’s why multi-year returns are measured as the compound annual growth rate (CAGR). It answers: what constant yearly return would have produced the same end result?
Compounding: time is the strongest force
Einstein supposedly called compound interest the eighth wonder of the world. The quote is probably made up, but the idea isn’t: when returns are reinvested, they earn returns of their own. Growth accelerates over time.
Play with the calculator: how much difference do ten extra years make? What about one extra percentage point of return?
A few insights that emerge:
- Time beats amount: Someone investing $200 a month from 25 at 7% ends up with far more at 65 than someone who starts at 40 and saves twice as much.
- The last years do the heavy lifting: Over long horizons, a large share of the final value is created in the last ten years.
- Small differences, big effect: One percentage point more or less a year – through fees, for example – changes the result after 30 years by roughly a fifth to a quarter.
The rule of 72
A handy rule of thumb: 72 divided by the annual return in percent gives roughly the years until money doubles.
| Return per year | Doubles after about |
|---|---|
| 2% | 36 years |
| 4% | 18 years |
| 6% | 12 years |
| 8% | 9 years |
| 10% | 7 years |
It works in reverse too: at 3% inflation, the purchasing power of your cash halves in about 24 years.
What’s a “normal” return?
To judge promises, history helps. The most comprehensive dataset comes from economists Elroy Dimson, Paul Marsh and Mike Staunton, who track returns since 1900 for dozens of countries. Roughly rounded, the real (inflation-adjusted) annual returns over that long period:
| Asset | Real return per year (approx., since 1900) |
|---|---|
| Global stocks | 5% |
| US stocks | 6–7% |
| Global government bonds | 2% |
| Treasury bills / cash | 1% |
These are averages over more than a century of world wars, hyperinflation, crashes and booms. Individual decades can be far above or below. And the US had the historic luck of being the most successful economy of the 20th century – which is no guarantee for the future.
More fine print
Time-weighted vs. money-weighted returns
If you invest regularly, there are two ways to measure your return. The time-weighted return shows how good the investment itself was, regardless of when you added money – that’s how funds report performance. The money-weighted return (internal rate of return) shows what you earned given your actual deposits and withdrawals. If you invested heavily just before a crash, your money-weighted return is worse than the fund’s.
Nominal vs. real
All returns in this lesson except the table above are nominal – before inflation. What matters for your purchasing power is the real return. That’s the subject of the next lesson.
Summary
Return measures the gain including all income. Over several years, the compound annual growth rate counts, because gains and losses don’t simply cancel out. Compounding makes time every investor’s most powerful ally, and the rule of 72 helps with mental math. Historically, broadly diversified stocks delivered the highest real returns – but never without swings.
Time to practise
13 short exercises on this lesson – mistakes come back at the end. Then the lesson is complete and joins your review queue.
Test your knowledge
0/401A stock rises 50% in year one and falls 50% in year two. What’s the result after two years?
02Roughly how long does it take money to double at 6% a year?
03A portfolio grows from $10,000 to $20,000 in 10 years. What was the average annual return?
04Why should you always look at total return for stocks?