Tyler York

May 23, 2023

You’ll need to calculate the total return of an investment strategy in order to pass the FINRA SIE and other exams, and in your work as an investment professional. In this video updated for 2023, we show you how to calculate total return, what things you need to watch out for, and then guide you through a total return problem in Achievable’s FINRA test programs.

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00:00:00 Let's talk total return. This is a calculation that on the surface can seem complex, can involve a lot of moving parts, and for those of us who were challenged by the formulas and the math on this exam can certainly be a little intimidating. But. 00:00:17 We're going to demystify it in this video, talk about how to approach it in the easiest way possible, and we're even going to look at a really difficult practice question and work through it together so that we better understand this concept. With that being said, let's put the practice question up on the board first and foremost, Breathe. This is a long question. Yes, it might seem intimidating at 1st, and there are a lot of numbers in this question. 00:00:44 But we're going to work through it together. We'll make it through. And by the end of this, I'm confident you're going to feel better about total return and how to make it through a question like this on the exam. Before we get started analyzing this question together, feel free to pause the video, see if you can get to the answer yourself, and then we'll talk from there. OK, You think you have it. 00:01:04 Let's look at it together. Here's just a test taking tip that I recommend. Anytime you come across a really long question like this, you might read through all this material, look at all these numbers, and not know what it is you're actually looking for. And sometimes the question can throw you for a loop and just come completely out of left field once you get to the very end. So what I recommend you do is go to the end of the prompt and figure out what the question actually is. 00:01:31 And here the question is, what is the investor's total return? What that will do is prevent you having to reread questions, not knowing what you're looking for along the way. I think it's a great practice for those really long questions that you inevitably will come across on the exam. OK, let's go ahead and read the question together. Now that we know what we're looking for, this is a total return question a year ago. 00:01:53 An investor made an initial deposit of $40,000 to their portfolio and made numerous investments. Since then, they have received 2000 in dividends, of which half were reinvested and half were held in cash in the portfolio. Additionally, they received $4000 in bond interest, none of which was reinvested. 00:02:12 Kept in cash in the portfolio while their securities have not been sold, they have also attained $1200 in capital appreciation. During the same time period, CPI was reported at 5%. What is the investor's total return? Wow, wow, wow. Again, that. That's a lot of information and you might stumble upon a question like this on the actual exam, so let's be prepared. Let's work through it together. 00:02:37 And let's demystify it. The first thing that we're going to do is talk about the total return calculation as we discussed in the achievable materials. I think the easiest way to remember it is all gains and or losses compiled together in the numerator on the top of the formula and we'll divide that by the original investment in the denominator at the bottom of the formula. If you think about the name total return, what we're trying to figure out is what is the overall rate of return that the. 00:03:07 Has received since they've made this original investment. When we say all gains and or losses, we're talking any kind of dividends that you might receive from stock, any kind of interest that might be received from a bond or any type of capital gain or capital loss on an investment in that capital gain or capital loss could be realized or unrealized. 00:03:29 Realized means that the investment has been sold and that gain or loss has been locked in. And an unrealized gain or loss is referred to sometimes as a paper gain or a paper loss. That just means it's a gain or loss that's on paper that has not yet been locked in. Because the investment hasn't been sold, it doesn't really matter what we have total return factors in both realized and unrealized gains. We can look at the very first sentence of this question and automatically fill in 1/2 of the formula and that would be the initial. 00:03:59 Deposit of $40,000, the only time we would add to the original investment is if the investor ever takes any outside cash and puts it into their portfolio into another investment. But if you look at this question, if we think back to what we saw, there's only one big infusion of cash and that's the $40,000 that was originally purchased in the beginning. Yes, there were some reinvested funds along the way, but that's money being made on top of money and that will not factor into the original investment part of this calculation, so. 00:04:29 Good news, we're already done with half of the formula, $40,000 is our original investment. Now the top part of this formula is the difficult part, but good news. We just have to take our time and go through the question methodically and make sure that we're accounting for everything along the way. In the second sentence, the investor receives $2000 in dividends. That will be part of the investors gains and so we will account for that on the side $2000.00 of dividends. The third sentence tells us that the investor received 4000. 00:04:59 Dollars in bond interest. This is also part of the gains they've made in their account, so we will account for that on the side. The next sentence mentions that these securities have not been sold. So these are unrealized gains we're about to talk about here. But there's $1200 of capital appreciation in the portfolio. Capital appreciation is growth also known as a capital gain. That is something we will account for on the side as a part of our total gains and or loses. Now the 2nd to last sentence mentions CPI. That is the. 00:05:29 Consumer price index, which is a reflection of inflation. Inflation is the rising cost of goods and services in an economy. This would be an important figure if we were asked about the real rate of return or the inflation adjusted return. Both of those are basically your total return minus the going inflation rate. But again, that's not what the question is focusing on total return does not factor in inflation into its calculations, so we will disregard that. We do not need that information to get to the answer. Be mindful. 00:05:59 That test questions oftentimes will give you a piece of information, maybe a few pieces of information that are not relevant to the answer. So part of this process is being a filter and knowing what the important stuff is and what the not important stuff is. So basically that's the only piece of information they give us in this question which is not terribly relevant to the answer at this point. We have now accounted for every piece of information we need to get to the right answer. We have the dividends. 00:06:26 The bond interest and the capital appreciation and when we Add all those numbers up, we get $7200 and that will be the number in our numerator. The top part of the formula, $7200 / 40,000 dollars is our calculation and that should give you 18 percent, 18% is the answer for this question. Hopefully now that we're through all of this, this question feels a little bit more manageable. It's all about taking your time. 00:06:54 Knowing what the question is asking for, filtering out the information that maybe is not useful and then just putting it all together. Total return. Simply stated are all the gains and or losses made in the portfolio divided by the original investment.

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