What is the Difference Between Gain and Return?
How am I doing? It is a common question among investors. We all want to measure how well we are managing our money. Of course, we can simply watch to see if the balance grows, but most of us would like to measure our returns, usually in the form of a percentage rate. Unfortunately, most brokerage houses, including Schwab, Fidelity, and Ameritrade, don’t provide an investment return, they provide a gain or loss percentage, which isn’t quite the same. While these gain or loss figures provide some useful information, they have some significant flaws when used to track performance. In this article, we’ll dive into the drawbacks of brokerage reporting and highlight a better way to look at performance.
Let’s begin by defining gain. Gain (or loss) is the difference between the purchase price of an investment and the current price of the investment. For example, let’s say that you purchased one share of Bank of America stock for $20 per share and it rose to $24 per share. Your gain is $24- $20 = $4. We can even calculate the percentage gain by dividing the gain by the amount invested ($4/$20) to arrive at a 20% gain. All of this is simple enough.
Gain is helpful information since it tells us how much the price has risen. However, it is an incomplete picture of return for a couple of reasons. First, gain excludes any distributions, such as interest, dividends, or capital gain distributions. For example, Bank of America pays annual dividends of 2%. These dividends are completely ignored in our gain calculation, but can often be a significant part of our return, especially over a period of years. Secondly, gain ignores any concept of time. Again, using our Bank of America example, our gain calculation makes no distinction between a purchase of Bank of America stock in 2008 for $20 and a purchase of Bank of America stock in 2016 for $20. Both investments would have a 20% ‘gain’ but clearly the purchase of Bank of America stock in 2016 was the better investment since it achieved the same return in far less time.
It is also important to remember that the investment gain shown on the typical brokerage website resets each time an investment is bought or sold. For example, let’s say we look at the holdings in our brokerage account and see that we have a 20% gain on Bank of America. If we sell Bank of America and then buy Facebook, the 20% gain from Bank of America will disappear from the total gain on the website. You can see how total gain can be a misleading indicator if you have multiple investments that were bought at different times. As different investments are bought and sold the total gain starts to become meaningless.
Thankfully, there is a better way to measure investment performance: time-weighted return. Time-weighted return incorporates gains and losses, interest, dividends, distributions, and time. Further, the calculation negates the impact of adding or taking away from your investment so you get a simple, pure reflection of how the investments performed, reflected in an annual percentage rate. Because of this, time-weighted return has become the industry standard for reporting investment returns, and is what most people are looking for when they ask, “How much did I make last year?”.
The calculation for time-weighted return is a bit more difficult which is why it is not immediately shown on most brokerage websites. Nonetheless, it is the industry standard measurement and so we do provide daily time-weighted return figures to our clients. Ultimately, we want to make sure that all our clients are able to track what is happening in their accounts.
*a version of this article first appeared July 31, 2017