What are the Different Types of Investment Returns?

When you invest, your goal is often to earn a return. But what exactly is an investment return, and what are the different types of investment returns, you expect? Understanding investment returns is crucial to making informed decisions and setting realistic expectations for your financial future. 

Returns have various types, each with its characteristics and potential for growth. Whether you are aiming for steady income, long-term capital appreciation, or a mix of both, knowing the different types of returns helps you navigate the world of investments more confidently. 

In this article, we will break down the various types of investment returns and explain how they can impact your portfolio.

Understanding Investment Returns

At its core, investment returns measure how much money you have gained or lost on an investment over time. Whether you are investing in stocks, real estate, or even a savings account, the concept of returns helps you understand whether your investment is growing and by how much.

Consider it this way: You plant a seed (investment), and you check to see how much it has grown over time. Your initial work results in growth, whether it’s a tiny seedling or a large tree. 

Different Types of Investment Returns

Investment returns can come in different types and be categorized in multiple ways. Understanding these different types of investment returns will help investors make better decisions regarding where and how to invest their money. 

1. Capital Gains

Capital gains refer to the profit earned from selling an asset, such as stocks, bonds, or real estate, for a higher price than what was originally paid. It is one of the most common ways to earn investment returns.

• Short-Term Capital Gains: These are gains from selling an asset within a year of buying it, which are taxed at a higher rate than long-term capital gains.

• Long-Term Capital Gains: These are gains from selling an asset held for more than a year. They are typically taxed at a lower rate than short-term gains, which makes long-term investing attractive for purposes.

Example of Capital Gains: If you buy a stock at $1,000 and sell it for $1,500 later, it is $500 ($1,500 – $1,000).

Asset	Purchase Price	Selling Price	Holding Period	Capital Gain	Types of Gain
Stock	$1,000	$1,500	2 years	$500	Long-Term Capital Gain
Real Estate	$200,000	$250,000	5 years	$50,000	Long-Term Capital Gain
Gold	$5,000	$5,800	6 month	$800	Short_term Capital Gain
Mutual Fund	$10,000	$12,000	3 years	$2,000	Long-Term Capital Gain

2. Dividend Income

Dividend income is the money earned by investors from holding shares in dividend-paying companies. Companies pay dividends to their shareholders as a portion of their earnings, usually on a quarterly or annual basis. 

• Dividends vs. Capital Gains: Unlike capital gains, dividends provide regular income without needing to sell the asset.

• Dividend Yield: It represents the yearly dividend income as a proportion of the current investment price. A high dividend yield indicates a higher income from the investments.

Dividend Income Example: Let’s say you own 200 shares of a company that pays an annual dividend of $10 per share. Your total dividend income would be:

$200 shares x $10 per share = $2000 annually.

3. Interest Income

Interest income is the return earned from investment in bonds, savings accounts, or other fixed-income securities. When you invest in these products, you earn interest on the principal amount you invested. 

• Fixed-Rate vs. Variable Rate: The interest remains the same throughout the investment period in fixed-rate investments. In variable-rate investments, the interest can change based on market conditions.

• Types of Interest Investments: Bonds are the most common example, where investors lend money to governments or corporations in exchange for regular interest payments. 

Example: If you invest in a government bond that pays 4% annual interest, and you invest $1,000, you would earn $40 in interest each year. 

4. Rental Income

The money received from renting out real estate properties is known as rental income. People who invest in residential or commercial rental properties often receive this type of return.

• Property Appreciation: Along with rental income, investors can also benefit from increased property value over time.

• Real Estate Investment Trusts: These companies own or finance income-producing real estate. Investors can invest without owning physical properties.

Example: If you buy a rental property for $150,000 and receive $1,200 in rent each month, your annual rental income would be $14,400.

5. Total Return

An overall indicator of an investment’s performance is its total return. Both capital gains and income are considered. Total return provides investors with a comprehensive view of their investment’s performance over time.

• Annualized Total Return: This represents the return on an investment over a year and adjusting for compounding.

• The formula for Total Return:

Example: If you invest in a mutual fund, and its value grows from $1,000 to $1,100 over a year while you receive $50 in dividends, the total return would be:

6. Unrealized Gains

The increase in the value of an investment that has not yet been sold is called unrealized gains. These are “paper gains” because they have not been converted into actual income and exist only on paper.

• Market Fluctuations: The value of investments such as stocks and real estate can vary. Until the asset is sold, there has been no realized gain, although its value is rising.
• Importance: Unrealized gains are important for investors because they can reflect the potential value of an investment. However, they also carry the risk of turning into losses if market conditions change. 

Example: If you buy 100 shares of a stock at $20 per share and the stock price rises to $30 per share, you have an unrealized gain of $1,000. But if you don’t sell the share, you haven’t made any actual profit yet. 

7. Realized Gains

When an asset is sold at a higher price than it was originally purchased for, a realized gain occurs. Unlike unrealized gains, which can fluctuate, these “realized” gains.

• Taxation: Realized gains are taxable. The tax rate on short-term capital gains is higher than that on long-term gains.
• Investment Strategy: Some investors may hold on to investments for the long term to benefit from long-term capital gains tax rates.

Example: If you sell a stock that you purchase for $500 for $700, you make a realized gain of $200.

8. Inflation-Adjusted Return

Inflation-adjusted returns are the returns on an investment after accounting for inflation because inflation reduces the purchasing power of money, so it’s important to know how your investment performs in real terms.

• Nominal Returns: The raw returns on investment without adjusting for inflation.
• Real Returns: The return after subtracting the inflation rate from the nominal return.

Example: If your investment earns a 6% return but inflation is 3%, your real return would be 3% (6% – 3%).

9. Risk-Adjusted Return

The return on an investment in proportion to the level of risk is measured by risk-adjusted returns. It helps investors evaluate how much return they are getting for the risk they are assuming.

• Sharpe Ratio: A common measure of risk-adjusted return. It calculates the return relative to the risk taken, with higher ratios indicating better risk-adjusted returns.
• Beta: A measure of an asset’s fluctuation compared to the entire market. A high beta indicates a higher risk.

Example: If an investment offers a 10% return with low volatility, its risk-adjusted return may be higher than an investment offering a 15% return with high volatility.

Key Takeaways

• Capital Gains: These are profits earned when you sell assets like stocks or real estate for a price higher than purchased.
• Dividend Income: Money earned from stocks or mutual funds that pay dividends.
• Interest Income: Money earned from bonds or savings accounts.
• Rental Income: Earnings from renting out real estate properties.
• Total Return: A comprehensive measure of an investment’s performance, considering both capital gains and income.
• Unrealized gains: Gains that exist on paper but have not yet been sold.
• Realized Gains: Actual gains made from selling an asset for more than its purchase price.
• Inflation-Adjusted Returns: Returns after considering the impact of inflation.
• Risk-Adjusted Returns: Evaluate the return concerning the risk taken.

Conclusion

Anyone who wants to grow their money should understand the different types of investment returns. If you understand concepts such as capital gains, dividends, interest, and other returns, you can make better decisions about where to invest your money. Understanding and evaluating these returns enables you to modify your investment strategy to meet your financial goals, whether you are looking for long-term growth or short-term income. 

FAQs: What are the Different Types of Investment Returns?

Why is it important to understand investment returns?

Understanding returns helps you make better investment decisions, align them with your financial goals, and minimize risks effectively.

Which types of returns are the safest?

Interest from fixed-income investments like bonds or savings accounts is usually the safest but often has lower returns compared to other types.

Can I earn multiple types of returns from one investment?

Yes, some investments, like stocks, can provide multiple returns, such as capital gains from appreciation and dividends as income.

How do I choose the right type of return for my goals?

It depends on your financial goals: For long-term growth, focus on capital gains; for steady income, look at dividends or interest.

Read More:
What are the 7 Types of Investment?

How To Get 15% Return on Investment

What Type of Investment is Best Protected From Inflation?