What it means
Cumulative return answers a simple question: for every dollar put in, how much do I now have, expressed as a percentage change. It is the most intuitive measure of investment performance and the one most often shown on statements and fund factsheets.
Its simplicity is also its weakness. The critical omission is time.
A cumulative return of 45% is excellent over three years and unremarkable over fifteen, so the figure is only meaningful when the period is stated. This is why professionals usually convert it into an annualised, or compound annual, return before comparing two investments.
Income must be included or the number understates performance badly. A share portfolio yielding 3% a year loses a large part of its measured return if only the price change is counted, so most published figures are stated on a total return basis, meaning dividends are assumed to be reinvested.
Cumulative returns compound rather than add. Three consecutive years of 10% do not produce 30%, they produce 33.1%, because each year's gain earns a return in the years that follow.
The same effect works against you on the way down, which is why a 50% fall requires a 100% rise to get back to level. One practical trap is that cumulative return ignores the timing of contributions.
If you added most of your money just before a fall, your personal experience will be far worse than the headline figure suggests, which is what money-weighted return measures are designed to capture.
In practice
Real-world examples.
Example
A pension member reviews a fund that shows a cumulative return of 62% since launch in 2018. Once annualised across seven years that is about 7.1% a year, which she can now compare fairly against her other holdings.
Example
A property investor buys a small commercial unit for $320,000, collects $96,000 of net rent over six years, and values it at $368,000. The cumulative return is ($368,000 - $320,000 + $96,000) / $320,000 = 45%, showing how much of the result came from income rather than price.
Example
A finance team benchmarks its corporate cash portfolio, which returned a cumulative 9.4% over four years against a short-term index at 8.1%. The 1.3 percentage point gap over the whole period sounds small, but on a $12,000,000 balance it is roughly $156,000.
Formula
Calculation
Cumulative Return = (Ending value - Beginning value + Income received) / Beginning value
An investor puts $50,000 into a fund. Five years later the holding is worth $68,000 and $4,500 of dividends have been received along the way.
Gain = $68,000 - $50,000 + $4,500 = $22,500
Cumulative Return = $22,500 / $50,000 = 0.45, or 45%
To make that comparable with other investments, convert it to an annualised figure by taking the fifth root of the growth factor: 1.45 raised to the power of 1/5 equals about 1.0771, so the compound annual return is roughly 7.7% a year. Note the difference in impression: 45% sounds impressive until it is spread across five years, at which point it reads as a solid but ordinary result.Case study
Seen in the real world.
The following is an illustrative, fictional scenario. Harborline Capital, an invented boutique investment firm, marketed a strategy on a single headline: a cumulative return of 128% since inception. The number was accurate, and it was also close to useless on its own.
Inception was eleven years earlier, so the annualised return was about 7.8%, roughly in line with a plain index fund available at a far lower fee. When a prospective institutional investor also asked for the return net of fees and for the pattern year by year, a second issue appeared: most of the gain came from two strong years near the start, with six of the following nine years slightly behind the benchmark.
Harborline eventually restated its materials to show annualised returns net of fees alongside calendar year figures. Assets under management fell in the short term, but the firm found that the investors who stayed asked better questions and redeemed less often during weak periods, because they had never been sold an expectation the strategy could not meet.
Watch out
Common mistakes.
- Quoting a cumulative return without the period. A percentage with no timeframe attached cannot be compared with anything and is the most common way performance is made to look better than it is.
- Adding annual returns together. Returns compound, so three years of 10% give 33.1% rather than 30%, and the error grows quickly over longer periods.
- Using price change only and calling it total return. Excluding dividends or interest can understate a long-run result by a third or more on an income-producing asset.
Questions
People also ask.
How do you convert cumulative return into an annual figure?
Take the growth factor, in other words 1 plus the cumulative return, raise it to the power of 1 divided by the number of years, then subtract 1.
Does cumulative return account for money paid in over time?
No, it assumes a single lump sum at the start, so investors making regular contributions should look at a money-weighted return such as the internal rate of return.
Can cumulative return be negative?
Yes, and it is floored at -100% for an ordinary investment, since the most you can lose is everything you put in unless the position was geared.
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