Calculating Total Return Including Dividends

Price Return is the return that looks only at the rise in price. Total Return is the return that adds to this the dividends received, assumed to have been 'reinvested.'

For an asset that pays dividends, these two diverge. If you ignore dividends and look only at price, you underestimate the actual performance. In particular, if you diligently reinvest dividends, compounding kicks in as those dividends generate further dividends.

The U.S. S&P 500's long-term average return of about 10% is on a 'total return' basis. The price return, reflecting only price, is roughly 6–7% per year, and the remaining roughly 3–4 percentage points come from dividends.

Over longer periods, the contribution of dividends stands out even more. According to various analyses, over long stretches since the mid-20th century, dividend reinvestment is thought to explain a substantial part of the S&P 500's total return (roughly the 40%-range up to more, depending on the data and period). Because the figure varies greatly by measurement period and method, it's safer to understand it as 'the share of dividends is by no means small' rather than pinning it to a single exact number.

If you calculate it directly, assume that at each dividend payment you bought more of the same asset with that dividend, increasing your share count over time. Then the effect of dividend reinvestment is reflected in the final valuation.

When looking at an index too, you have to look at the 'Total Return Index' rather than the 'price index' for dividends to be included. When comparing performance, mixing your own return (dividends included) with the benchmark (price index) creates an illusion, so you have to match them on the same basis.