Look at the total rate of return

When saving or investing, be it in a bank or building society account, or in stocks and shares it is important to establish how you want to achieve a return from that investment and also what the total return might be.

An investment in a building society account will generate interest on the amount saved, with the amount being added to the balance on a periodic basis. The value of the initial capital investment does not increase. The balance itself may only rise due to further investment, possibly by the re-investment of interest.

The percentage rate of return will be easy to see as it will be advertised by the building society, but is calculated by dividing the interest received by the balance in the account. This is known as a basic rate of return.

An investment in equities on the other hand will usually give rise to a dividend, on a periodic basis, in a similar way to bank interest. However dividends on ordinary shares are not guaranteed and fluctuate from year to year depending on profitability and reinvestment requirements. The basic rate of return is known as the dividend yield is calculated by dividing the dividend received by the price of the share.

The price of the share can go up or down for a whole host of reasons, be they company specific, macro-economic or just market sentiment. Assuming the share price increases this will generate a capital return.

The basic return and the capital return together give the total rate of return. It is this return that should be considered when making investment decisions and determining whether the rewards are worth the risks.

Individual circumstances always play a part and it isn’t just the ‘how much’ but also the ‘how’. That is, do you want the gains to take the form of income or capital? Also what are the tax implications of generating such returns?