As times and markets change, so do the thresholds for what is considered a respectable rate of return on an investment, that seemingly magical number that signifies the income generated by the investment as a percentage of its initial cost. A "good" rate of return for you is ultimately, in some measure, dependent on your own financial goals. The key to boiling down your expectations to a specific number for various investments is to not become overly enamored of any one number or range of percentages.
Relative to Existing Market Conditions
A rate of return that was considered good in one era may no longer be so in another. Market conditions change and old standards give way to new, and what was once "high" or "good" could now be considered shooting for the moon. If the stock market as represented by the S&P 500 is netting a 7 percent annual rate of return, an investment that has an 8 percent rate of return may not be your idea of a dream investment, but it is still doing better than one of the leading benchmarks. Financial planner Peter Dunn also notes why it is important that your investments at least keep pace with prevailing rates of return on "the market," namely the going return on standard stock market indexes such as the S&P 500. If your investment is not beating this standard, he says, you are probably paying more in management fees than if you just owned an index fund. Consistently beating the market over time is what ensures that you are not paying more in fees.
The personal investment site "Investing for Me" underscores the necessity of pinpointing a rate of return figure that is not just "good," but realistic, as well. To expect 10 percent or more yearly may be setting yourself up for disappointment. To offer a comparison: figures produced by actuarial reports of large pension plans in 2012 barely cleared 4 percent. Pension plans, which are managed over the long term by experienced managers who must maintain realistic expectations in order to succeed, provide a general idea of what to expect from the market -- and your own investments.
ROR as a Function of Asset Class
Rates of return are calculated differently depending on the investment. For stocks, you compute an annual rate of return based on the annual dividend as a percentage of the price paid for the stock. A bond's annual rate of return would be the annual interest income over the bond's purchase price. Although rates of return often are compared across asset classes, investors who want to pinpoint "good" targets for a return are better off comparing apples to apples. Portfolio Solutions predicts that, as of 2012, the next 30 years will see U.S Treasury bills with one-month maturity reaching rates of return of 0.3 percent, adjusted for inflation; the rate of return for 10-year, high-yield corporate bonds will be 4 percent; and U.S. small-value stocks will have rates of return of 7.5 percent.
Different Types of ROR
Before pinpointing your desired rate of return, see that the ROR you have in mind is the same as the one touted by your investment company. The latter may cite an "average" rate of return, in which case you should determine whether that is the geometric or the arithmetic version, which can differ significantly. "Total return" accounts for capital gains as well as dividend and interest income. Cumulative return is a similar concept for the total increase in value over a number of years. When you speak of rate of return, are you talking about nominal returns, which give the full return, including inflation, or real rate of return, which removes inflation? Make this clear before you make any comparison.
Video of the Day
- Pete the Planner: What Rate of Return Should You Expect to Earn on Your Investments?
- Investing for Me: What Rate of Return Will Your Investments Earn in the Future – 12%, 8%, 4%?
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- Portfolio Solutions: The Portfolio Solutions 30-Year Market Forecast for 2012
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