Investment Returns

The whole unit on one sheet: what you earn, how you measure it, and the dates and cost-basis rules the exam loves.

Components of Return

• Investment return = income + capital changes.
• Income: interest (debt) and dividends (equity), the money the investment pays you.
• Capital changes: realized gains/losses (security sold) and unrealized gains/losses (still held, "paper" gains).
• Return of capital: a distribution NOT from earnings, so it is not taxable when received; it reduces cost basis. Once basis hits zero, further return of capital is taxable as a capital gain.

Measurement Concepts

• Current yield = Annual Income / Current Market Price. Measures income only; ignores capital gains.
• Yield to maturity (YTM): total annual return if held to maturity (coupon + gain/loss at par + time).
• Yield to call (YTC): same idea assuming the bond is called early at the earliest call date.
• Total return = (Income + Capital Gain or Loss) / Initial Investment. The most comprehensive measure.
• Basis point (bp): 1 bp = 0.01%; 100 bps = 1%.
• Yield and price move in opposite directions.
• Discount bond (non-callable): YTM > Current Yield > Coupon. Premium bond: Coupon > Current Yield > YTM.
• Callable premium bond: YTC is the lowest (worst-case). Callable discount bond called at par: YTC is the highest.

Types of Dividends

• Cash dividend: taxable, usually as ordinary income; qualified dividends get the lower long-term capital gains rate but are still taxable. Board of directors declares it.
• Stock dividend: not taxable when received; total cost basis unchanged, per-share basis decreases.
• Return of capital: not taxable when received; total cost basis decreases.

The Dividend Timeline (D-E-R-P)

Order: Declaration → Ex-date → Record → Payable.

• Declaration date: board announces the dividend (set by the company).
• Ex-dividend date: first day the stock trades WITHOUT the dividend. Set by the listing exchange (listed stocks) or FINRA (OTC), NOT the company.
• Record date: shareholders on the books this day get paid (company).
• Payable date: the dividend is actually paid (company).
• Under T+1 settlement, the ex-date is the same business day as the record date.
• Buy before the ex-date = you ARE entitled. Buy on or after = NOT entitled.
• On the ex-date the price typically drops by about the dividend amount; this is a market adjustment, not a loss.

Cost Basis

• Cost basis = purchase price + commissions and fees.
• Reinvested dividends increase total basis; stock splits and stock dividends leave total basis unchanged (per-share drops); return of capital lowers total basis.
• Methods: FIFO (first in, first out) is the IRS default; specific identification gives maximum tax control; average cost divides total cost by total shares.

Benchmarks and Indices

• DJIA: 30 stocks, price-weighted.
• S&P 500, NASDAQ, Russell 2000: market-cap weighted. Russell 2000 = small-cap.
• Bloomberg Aggregate Bond Index: the go-to fixed-income benchmark.
• You cannot invest directly in an index; index funds and exchange-traded funds (ETFs) track it.

Numbers to Lock In

Memory Aid

• D-E-R-P: Declaration, Ex-date, Record, Payable.

Top Gotchas

• A rising, unsold stock is an unrealized gain; it becomes realized only when you sell.
• Current yield only measures income; if a question asks total performance, it is the wrong answer.
• Cash dividends are taxable; stock dividends are not. Qualified does not mean tax-free.
• Buy on the ex-date = no dividend (settles after the record date).
• Return of capital reduces basis, which increases the taxable gain when you sell.
• The DJIA is price-weighted, NOT market-cap weighted.

One-Breath Recap

Return is income plus capital changes; measure it with current yield, YTM, YTC, or total return; know that only cash dividends are taxable; nail the D-E-R-P timeline and the ex-date rule; and remember the DJIA is price-weighted while you cannot buy an index directly.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Investment Returns unit for the complete lesson.