The investment world is a performance game. People invest in hopes of making money, to earn a good or satisfactory return on their investments (index, single stock, ETFs, portfolios, mutual funds, etc.).

Total returns reflect both capital/market gains or losses in the investment and income received from the investment. Income comes from the dividends paid by stocks and the interest or yield paid by bonds. Together, those capital returns and income returns make up total returns.

Example: The MSCI World Index earned a 24.4% total return in 2023. That was based on a 21.8% capital return (the amount the index appreciated during the year) plus a 2.6% income return (the total of the dividends the index received from its constituent stocks for the year).

According to investment industry conventions, total return numbers for periods longer than one year are typically represented as annualized returns. We can think of an annualized return as an average, except that it takes a compounding effect into account. In other words, it recognizes that if an investment made gains in the first year, then it has more to invest at the beginning of the next year.

As an example, at the end of June 2022 the MSCI World Index had a three-year annualized total return of 7.52%. The index investment never actually earned that exact amount in any year. But if one had bought the index at the beginning of July 2019 and hung on for the next three years, that´s what one´s per-year earnings would work out to be.

The total return number is calculated on the assumption that shareholders reinvest any distributions or payouts (income they receive from dividend-paying stocks or interest-paying bonds) that their investment makes.  

Putting Returns in Perspective

Imagine an investment that has gained an average of 10% per year for the past three years. If another investment is up 13% per year, the prior investment lags by three percentage points. However, this does not say much about its performance. To know how an investment is doing, one cannot look at returns in isolation; context is what matters. One needs to make proper apple-to-apple comparisons by using an appropriate yardstick such as an investment of the same or similar type, a comparable peer group (category) and an index to judge its performance.

An index is a group of securities and is the most common kind of benchmark. Investments should be compared with an index, sometimes more than one. How are they performing versus their peer group and relative to the relevant index, leading or lagging, outperforming or underperforming?

Which returns should one consider? How the investment did for the past 3 months, the last 10 years, or some period in between? Long-term investors should focus on an investment´s returns for the past 3, 5 and 10 years – even 20 years for retirement purposes. They should compare those returns with those of other investments in the same category to get a clear view of performance. There is no point in buying or holding an investment that is inferior for most periods.

Also take a look at the investment´s calendar-year returns versus its category and index. That is a handy way to identify an investment that may look good because of a couple of strong recent years, but a look at year-to-year calendar returns reveals that prior to its recent winning streak, the investment had been a terrible place to invest.

Finally, check an investment´s performance over several time periods, including its year-to-year returns to see how consistent or volatile its performance has been. I always prefer rolling returns over trailing returns, which will be the subject of future posts.

This is my last post on the returns of the MSCI World Index. My final chart shows the rolling one-year returns in U.S. dollars for the MSCI World Index; it is the smallest timespan I use for rolling returns. In line with industry standards, the 1-year return numbers are non-annualized.

Currently, using the end of March 2024 numbers as the latest values, the 12-month real total return is about 21.5% and has been positive since May of last year.

In my series about the returns of the MSCI World Index, I started with annual or calendar year price and total returns in U.S. dollars (USD) and Icelandic kronas (ISK) from 1988 to 2023, and showed the returns in relation to their means and standard deviations.

The following posts displayed rolling price and total returns both in USD and ISK over four different time periods: 3-, 5-, 10- and 20-years. Next I calculated the compounded annual growth rates (CAGRs) and showed the cumulative (or holding period) price and total returns in USD and ISK through growth of a 100 charts, using both linear and semi-log y-scales.

Then I adjusted the price and total returns for inflation in the United States. Finally, I displayed the different measures of return for each rolling period in five single charts. I left out showing charts of the rolling price and total returns in ISK, and the CAGRs and cumulative price and total returns in ISK, after taking into account U.S. CPI.

Instead of the MSCI World Index, I could have chosen another global stock market index such as the MSCI All Country World Index (ACWI), FTSE All-World Index, or just the S&P 500 index in the U.S.

In the four charts below, I display four different measures of return in each chart: price, total, inflation-adjusted price and inflation-adjusted total. To those who argue that stock market indices should always be plotted as total return, i.e., with dividends reinvested, I suggest they also adjust the indexes for inflation to measure their real or true return values.

The effect of including dividends (total return) and the effect of inflation (real return) often cancel or neutralize each other, as can be seen in the rolling 10- and 20-year returns charts where the real total return tracks rather closely the price-only or nominal return – especially since 2008.

Below are charts showing the rolling inflation-adjusted total returns in U.S. dollars for the MSCI World Index. Since the Index is denominated in USD, it is adjusted for inflation using the U.S. Consumer Price Index (CPI) for All Urban Consumers: All Items.

Below are charts showing the rolling inflation-adjusted price returns in U.S. dollars for the MSCI World Index. Since the Index is denominated in USD, it is adjusted for inflation using the U.S. Consumer Price Index (CPI) for All Urban Consumers: All Items.

Over the 36-year period, the compounded annual growth rate (CAGR) for the total return numbers is 8.3% in USD and 12.4% in ISK. For the price returns, it is 5.9% and 9.9%. So both exchange rate movements and total returns matter a lot, as can be seen more clearly in the two charts below.

The cumulative total return for the MSCI World Index over the 36-year period is 1.654% in US dollars and 6.712% in Icelandic kronas. In other words, a 100-unit invested at the end of 1987 was worth 1.754 dollars and 6.712 kronas at the end of last year (2023).

The cumulative price return for the MSCI World Index over the 36-year period is 677% in US dollars and 2.872% in Icelandic kronas. In other words, a 100-unit invested at the end of 1987 was worth 777 dollars and 2.972 kronas at the end of last year (2023).

Here using a more proper semi-log y-axis scale with base 10.

Compounded Annual Rates (CARs) using monthly data, with end of first quarter or March 2024 as latest value. The blue line shows the average over the period. The returns are annualized, as per industry standards, and all charts show the same type of y-axis scaling and the same maximum, minimum and interval levels for easier and proper comparison.

Compounded Annual Rates (CARs) using monthly data, with end of first quarter or March 2024 as latest value. The blue line shows the average over the period. The returns are annualized, as per industry standards, and all charts show the same type of y-axis scaling and the same maximum, minimum and interval levels for easier and proper comparison.

Compounded Annual Rates (CARs) using monthly data, with end of first quarter or March 2024 as latest value. The blue line shows the average over the period. The returns are annualized, as per industry standards, and all charts show the same type of y-axis scaling.

Compounded Annual Rates (CARs) using monthly data, with end of first quarter or March 2024 as latest value. The blue line shows the average over the period. The returns are annualized, as per industry standards, and all charts show the same type of y-axis scaling.