Whenever you see a ‘total return’ for a mutual fund or exchange-traded fund, it is assuming that the dividends are reinvested. How do they calculate this? It’s a fairly easy but time-consuming exercise. Regardless of whether or not you want to calculate total returns on your own, it is still a good idea to know the math.
For this exercise I have chosen the iShares Russell Midcap Index Fund (IWR):
We are going to calculate the 2006 total return for IWR. To do so, you will need the following information:
1. The beginning date and price. For this exercise, I chose the beginning date of 12/30/2005, which had a closing price of $88.08.
2. The distribution history and the closing price on the ex-date (the date in the first column).
Here’s the information we need in order to make the calculation:
To calculate the total return for 2006, we will assume that we bought ONE share at $88.08 on 12/30/2005. The transaction history for 2006 would look like this (don’t worry if you don’t understand all the columns as I’ll explain each one):
As I said in the last paragraph, we assume we owned 1 share at the beginning of the year. We continued to own just one share until the first distribution of $.29138 was paid on 3/24/2006. Since we owned one share, our total amount received from that distribution was $.29138 (a little less than 30 cents). Remember that total returns are calculated by reinvesting dividends and distributions. So, we have to reinvest our $.29138. To calculate out how many shares our $.29 will purchase you divide $.29138 by the closing price on the distribution date, which was $94.12.
So, our $.29 distribution purchased us an additional .0030958 shares! Wooo Hooo! So we now own 1.0030958 shares until the next distribution date (6/22/2006). Notice on the second distribution date that we are receiving a distribution of $.332862 on 1.0030958 shares. This is the beauty of compounding.
We continue this same process for the rest of the year and end up the year with 1.013984 shares for a total value of $101.3274.
One share was worth $88.08 on 12/30/2005 and $101.3274 on 12/29/2006 (with dividends reinvested). Our total return for the year was:
Notice that our total return calculation MATCHES the return that iShares has:
Pretty cool, eh? Now you know how total returns are calculated.