By: Dr. K. C. Gupta

Total return (TR) includes dividends or interest plus price appreciation. But the concept gets more interesting beyond this basic idea.

For stocks, earnings play an important role, and TR can be broken down into three components:
%TR = %Dividend Yield + %Earnings Growth + %Change in P/E Ratio.

If you buy stocks when P/Es are high, changes in P/E may be negative when you sell, hurting your TR. Conversely, if you buy when P/Es are low, you could benefit. For people in the accumulation phase, dollar-cost-averaging (DCA) works well.

While this decomposition is exact for historical data, strategists often use future projections for these three terms to forecast market returns. Over the long term, changes in P/E ratios tend to have small annualized effects, so total return can often be approximated by:
%TR ≈ %Dividend Yield + %Earnings Growth.

If dividend yields are around 2–4% and earnings growth is 5–10%, the long-term TR would range from 7–14%. Commonly, people expect an 8–10% long-term return for stocks.
Notable growth ETFs include SPYG, VUG, and QQQ; blend ETFs include IVV, SPY, VOO, RSP, TCAF (active), and VTI.

If the emphasis shifts toward dividend growth, an alternative decomposition is:
%TR = %Dividend Yield + %Dividend Growth + %Change in P/D Ratio,
and for long-term projections:
%TR ≈ %Dividend Yield + %Dividend Growth.

Funds emphasizing dividends include:

• Current dividends: VYM
• Dividend growth: VIG, NOBL
• Dividend blend: SCHD

However, it should be noted that higher dividend yields may come at the expense of earnings or dividend growth.

The late John Bogle, founder of Vanguard, popularized these total return formulas through his books, writings, and speeches.

Bonds and Total Return

Bonds pay interest at a coupon rate and mature at par, which may result in capital gains or losses depending on purchase price. Bond total return assumes reinvestment of interest and is generally captured by yield-to-maturity (YTM).

When the current market interest rate is lower or higher than the bond’s coupon rate, bonds trade at premiums or discounts, respectively, to provide an acceptable YTM. At very high current prices, bonds may even offer negative YTM (as was the case with some sovereign bonds during the zero-interest-rate policy or ZIRP period).

Some bonds have a call provision that allows early repayment. In such cases, yield-to-call (YTC) is used. For bonds with complex call structures, yield-to-worst (YTW) is calculated based on the worst-case scenario for investors. Since call decisions favor the issuer, bond investors must account for this uncertainty.
However, if a bond defaults, these yield concepts become irrelevant and the investor could face large losses.

Bond Portfolios and SEC Yield

For bond portfolios and bond funds, calculating YTM becomes tricky due to underlying assumptions. To maintain consistency, the SEC prescribes a standardized but complex calculation — the 30-day SEC yield (based on Form N-1A) — which provides an indication of the fund’s prospective long-term TR.

An important observation: most of the total return for a bond fund held for its duration is simply the initial 30-day SEC yield.
Duration (d) measures interest rate sensitivity — a 1% (100 basis points) change in interest rates causes an approximately d% opposite change in portfolio value.

For example, the Treasury ETF IEF currently has:

• 30-day SEC yield: 4.12%
• Duration: 7.14 years

Thus, its approximate TR over 7.14 years would be about 4.12%. If rates were to suddenly rise by 100 basis points, the fund’s value would drop by roughly 7.14%.

The weighted-average price of a bond portfolio (above or below par) can signal whether it holds mainly premium or discount bonds.

• Funds with premium bonds may offer higher distributions but face declining NAVs.
• Funds with discount bonds may prioritize long-term capital gains and often brand themselves as following a total-return strategy.

Final Thoughts on Total Return

Total return for both stocks and bonds is meaningful only if dividends and interest are reinvested. If income is used for living expenses instead, measuring true total return becomes subjective — leading to ongoing debates about income-priority versus total return approaches (also discussed in “Portfolio Income & Withdrawals,” 12/26/24).

A handy tool: the Rule of 72
It says that money doubles approximately in 72 ÷ (%TR) years.
Example: at a TR of 6%, money doubles in about 12 years (72/6 = 12). The precise answer is 11.8957 years.

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