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Different types of return

An animated video explaining the different types of return investors should expect from different types of financial asset.

 

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For most asset classes, the total return comes from two main sources: capital growth and income. Capital growth comes from changes in the value of an asset. Income, on the other hand, comes from dividends in the case of equities or interest in the case of bonds.

With equities, the bulk of the total return normally comes from capital growth.

Shares are traded on the stock exchange and their prices fluctuate constantly according to demand and supply. 

For example, if you’ve bought shares in company X and then the company releases a successful new product, more people might want to buy the company’s shares, so the share price might rise. This would give you capital growth on your investment.

However, a few months down the line a rival might release an even better product, so people might be less interested in buying company X’s shares, and the price might fall. Now you might have a capital loss.

Share prices tend to be more volatile than bond prices in the short term, partly because they are a higher-risk asset. For example, if a company goes bust, shareholders stand behind bond investors in the queue to be repaid.

The flipside of this higher short-term volatility is that equities provide a higher long-term return than bonds.

Shareholders can also receive income, in the form of company dividends. If a company makes a profit, it might decide to pay some of that profit to its shareholders as a dividend.

But it doesn’t have to. If profits are low, companies can reduce their dividends, and when times are really hard they can stop paying dividends altogether.

What about bonds?

With bonds, income typically provides the main source of total return.

And, unlike equities, the income is written into the legal structure of the investment. The bond issuer agrees to pay the investor a set amount of interest, normally twice a year.

Bonds are also traded on the open market and their prices move too, as a result of factors such as interest rates and inflation. These bond price moves lead to capital gains or losses, just like with equities. But the difference is that bond price movements are usually much more modest than is the case with equities.

So, bond returns are more weighted towards income, and the income is more predictable than with equities. This greater security, together with the smaller price fluctuations and the fact that bond holders get paid before shareholders if a company goes bust, are what makes bonds a lower-risk investment than equities.

Investment risk information:

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested. Past performance is not a reliable indicator of future results.

Other important information:

This video was produced by Vanguard Asset Management, Ltd. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

If this is to be used on third party websites for an audience of professional investors as the submission suggests I would also include the for professional investors disclaimer at the top.

Issued by Vanguard Asset Management, Limited which is authorised and regulated in the UK by the Financial Conduct Authority.

© 2018 Vanguard Asset Management, Limited. All rights reserved.