Weekend Money: Mary Holm's Money Matters

Be clear about dividends when calculating returns

Q: In January 1991, I put $A2500 into BT Select Markets International Fund in Australia.

Since then, I have invested further lump sums and reinvested dividends in order to dollar cost average, as we are all bidden to do.

My records show the lump sum investments (in Australian dollars) as follows:

January 1991, $2500; August 1992, $2000; November 1993, $13,000; February 1997, $4931. The total is $22,431.

Add dividends reinvested, $16,219. Add dividends not reinvested early this year, $1640. The grand total is $40,290.

The fund value at April 1 1999 is $42,648.

My records and/or maths may be in error, and I would be happy for BT to release any figures to you. It just seems to me that I have put in a lot and am not showing a great amount over and above that as gain.

Another factor is that I have paid tax at 33 per cent on all my dividends, so how do I factor this in to assess whether this has been a good investment?

A: What are you complaining about? You've made a before-tax return of around 16 per cent. In this low-inflation environment, that's great.

I took up your suggestion that I check your numbers with BT. You did get a few figures wrong, which I've corrected in your letter. You also forgot about some dividends you didn't reinvest back in 1994 and 95, totalling $2877.

More to the point, though, there's a basic error in your reasoning.

You're counting your dividends as capital - money you put into the fund.

That's incorrect. You would never have had that dividend money if you hadn't made the investment.

Dividends are part of your return, just like interest on a term deposit or rent on an investment property. The other part of the return is the growth in the value of the shares the fund has invested in.

In your case, the capital you put in totals $22,431. All the rest, up to $42,648, is return.

You should also include in your return the $2877 and $1640 of dividends you didn't reinvest.

And you need to make an allowance for your use of that dividend money since you received it. (Think of it as interest you might have earned in a bank account.) Let's say you could have made around $1200 over the years on those dividends.

That brings the value of your investment on April 1 to $42,648 plus $2877, $1640 and $1200. Total: $48,365.

You've more than doubled your money. That's pretty good, given that some of your investments haven't been in the fund for very long.

Working out your return when you've put in different amounts for different periods is not straightforward. I've had several other letters from people struggling to do something similar.

You can use a computer - more on that in a minute. Or you can make an estimate, using a basic calculator and trial and error.

Here's how I came up with nearly 16 per cent on your investment. Firstly, we need a rough figure to start from.

According to the information BT sends to investors, your fund returned 20.4 per cent, with dividends reinvested, over the seven years to last January. But that excludes upfront fees and taxes.

After fees but before taxes (although there could be some Aussie resident withholding tax taken out) let's guess at 15 per cent.

What do we apply it to - bearing in mind that we don't want to make too many calculations? That calls for using some average-ish numbers.

Three of your lump sum investments, totalling $17,500, were made between January 1991 and November 1993. Given that by far the biggest amount was at the end, we'll lean in that direction and say you invested the full $17,500 on April 1 1993. So we're looking at a six-year investment of that amount.

Your February 1997 investment of $4931 was made in such a different time frame that we need to treat it separately. Let's call it a two-year investment.

On your calculator, multiply $17,500 by 1.15. That tells you how much you would have after one year, with a 15 per cent return. Then multiply that answer by 1.15 to get the two-year result, and so on, till you get the six-year result. In this case, it's $40,479.

Then do the same with the $4931 for two years. You'll get $6521. Add the $40,479 and you get $47,000.

That's a fair bit short of the $48,365 your investment is worth today (including the dividends not reinvested). Would 16 per cent be more accurate?

This time, multiply by 1.16. You should get $42,637 plus $6635, which totals $49,272. That's too high, but closer to our target.

We conclude, then, that your return is a bit under 16 per cent. As I said, not bad at all.

I referred earlier to using a computer to calculate your return more accurately. If you've got access to Excel, look under Tools and click Data Analysis. Then do a search for "rate of return".

BT did just that on your investment, and came up with a return of 16.7 per cent. That's so close that we won't worry about the difference.

What could be more worrying is the issue you brought up about tax. Distributions from Australian-based unit trusts are treated as dividends and included in your taxable income.

In your case, you re paying tax of 33 per cent on dividends. And clearly, from your numbers, dividends make up most of your total return.

If they were the whole lot, that would reduce your return from around 16 per cent to around 11 per cent. That's still pretty good. But you might not feel so relaxed about it if returns dropped and it was reducing a return of 6 per cent to 4 per cent.

You should note, too, that you might have to pay tax when you take money out of an Aussie unit trust. It depends on your circumstances and how you make the withdrawal. It might be worth getting professional advice at the time.

BT can provide information on this.

* Got a question about money? Send it to Money Matters, Business Herald, PO Box 32, Auckland; fax: (09) 480-2054; or e-mail: maryh@journalist.com.
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