Total cumulative return is the total profit earned on an investment. The profit includes any increase in price, dividends and interest the investment earned. The return rate is typically presented as a percentage of change over the given time. The total cumulative return provides valuable information regarding rates of return, but it does not tell a complete story and should be used with other return indicators to determine an investment's value.
Cumulative total return periods vary, depending on time-frames. An investment's cumulative return may be reviewed annually or over a longer period, such as 5, 10 or 30 years. To determine the gross return, subtract the starting investment from the current price and add any dividends, interest or other income the investment has earned through that period. For example, if the initial investment was $5,000 and one year later it's worth $6,000 and has also earned $400 in dividends: 6,000 minus 5,000 plus 400 equals $1,400 total cumulative return over the one-year period reviewed.
Converting to a Percentage Return
To convert the gross return into a percentage, which is useful to compare investment returns, use the same formula as above and divide the answer by the initial investment. In the above example, divide $1,400 by $5,000, which equals 0.28. Multiply that number by 100 to convert it to a percentage, and the cumulative total return on this investment is shown to be 28 percent.
What Is Not Considered
The cumulative total return is a quick estimation on the percentage of return an investment has earned over a period. When considering this calculation over long periods, such as five years or longer, one aspect is not incorporated into the calculation -- the value of money. The value of money changes over time. The saying "A dollar doesn't buy what it used to" demonstrates this principle. The value of money has typically declined over the years, eating into the real return on the investment.
Annual Compound Growth Rate
Another tool to consider is using the annual compound growth rate. This is a method of calculating annual performance, especially in a volatile market. For instance, if a $1,000 investment increased by 100 percent after one year, and had lost 50 percent by the end of the second year, it might appear that its annual growth was 25 percent [(100% - 50%)/2 years]. In reality, the investment's value is $2,000 at the end of the first year, and $1,000 again at the end of the second year, for a net return of 0.00 percent. The annual compound growth rate is a formula that "smooths" annual changes as if the change had taken place steadily. Technically speaking, it is the geometric average.
Michael Carpenter has been writing blogs since 2007. He is a mortgage specialist with over 12 years of experience as well as an expert in financing, credit, budgeting and real estate. Michael holds licenses in both real estate and life and health insurance.