Analyzing Returns: How You Make Money From Saving & Investing
When you save or invest money, you have the potential to make money in a variety of different ways. Today’s blog is going to explore a few of those ways, to hopefully give you a better understanding of the opportunities out there, and to give you a clearer picture when setting your goals.
Analyzing Returns
Each type of investment has its own blend of associated risks when you choose to put your hard-earned dollars into that investment; likewise, each offers a different potential as far as the rate of return. First, let us walk through the components of how to calculate the total return on an investment.
The Components of Total Return
To figure out exactly how much money you have made (or lost) on your investment, you need to know how to calculate your total return. To produce this figure, you need to know how much you originally invested, and how much the property has appreciated (or depreciated). And if you want to go deeper, you can factor in other components such as interest & dividends.
Banks
If you have ever had money in the bank, you know that the bank pays you a small amount of interest when you allow it to keep your money there. The rate of interest is known as the yield. So, if a bank tells you that its savings account pays 2 percent interest, it may also say the account yields 2%. Banks usually quote interest rates or yields on an annual basis.
Interest that you receive is one component of the return you can receive on savings & investments.
Bonds
When you lend your money directly to a company – which is what you do when you invest in a bond that a corporation issues – you also receive interest. Bonds, like stocks, fluctuate in value after they are issued.
When you lend money to a company (or even the government, with treasury bonds and the like) they typically pay you a set rate of interest. Bonds generally offer higher yields than bank accounts, usually without the extreme volatility of the stock market (however, as noted above, their price can fluctuate). So, we might say that bonds are similar to CDs, except that bond are securities that trade in the market with a fluctuating value.
How they work: for example, let’s say you purchase a corporate bond that is scheduled to mature 5 years from now, and it is paying 3%. The company sends you interest payments on the bond for 5 years. And as long as the company does not have a financial catastrophe, the company returns your original investment after the 5 years is up.
Stocks
When you invest in a company’s stock, you are purchasing a tiny share of ownership in the company. You hope that the stock increases – or appreciates – in value. Of course, a stock can also decline in value. This change in market value is part of the return on your investment.
Here is the formula you need in order to calculate the total return on your investment:
(Current Investment Value – Original Investment) / Original Investment = Appreciation (or depreciation)
For example, let’s say that 1 year ago, you invested $1,000 into shares of stock (let’s say that you bought ten shares at $100 per share), and today that investment is worth $1,100 (each share is now worth $110) your investment appreciation looks like this:
($1,100 – $1,000) / $1,000 = 10%
Your total return is 10%.
Stocks can also pay dividends, which is when the companies share some of the profits with you as a shareholder. (Note: some companies, particularly those that are small or that are growing rapidly, decide not to pay a dividend, and reinvest all the profits back into the company).
To get your total return in this instance, you need to factor in your dividend as well.
So, from the previous example, in addition to your stock appreciating from $1,000 to $1,100, it paid you a dividend of $10 ($1 per share).
Here is how to calculate your total return:
((Current Value – Original Investment) + Dividends) / Original Investment = Total Return
(($1,100 – $1,000) + $10) / $1,000 = 11%
The Emotional Component
Turning profits and growing wealth can be a powerful motivating factor behind investment decisions. However, it would be wise to consider more than the bottom line. Some people like the idea of high returns – but they do not have the stomach for the market volatility. This often causes people to panic – to sell at the wrong time and buy at the wrong time.
These mistakes in timing (poor decision making) is why, according to DALBAR, the average investor tends to average less than 4% return on their investments, even when the market itself may return 8% or 10% during the same time period.
In addition, some people want to have fun with their investments. They like the roller coaster ride, although they do not necessarily want to lose money or sacrifice potential return. (Fortunately, less expensive ways to have fun do exist!)
Psychologically, some investors choose particular types of investment vehicles such as individual stocks, real estate, or a small business over a broad portfolio managed by professionals. Why?
Well because compared with other investments, such as managed money, ETFs, etc., they see these investments as more tangible, and well… more fun.
Be honest with yourself about why you choose the investments that you do. Allowing your ego to get in the way can be extremely dangerous.
When you buy individual stocks, are you doing so for a particular reason?
Do you truly believe that your stock picking skills will lead to better results than the efforts of the best full time money managers? (Chances are that they will not)
Have you truly put in the work to become educated on the different companies you are investing in?
I am not saying that you cannot have some fun, or that you cannot do a good job picking some stocks. But do you really want to do it with your entire portfolio? We are talking about YOUR future – are you investing, or gambling?
For professional money management, I recommend our team at Brookstone Capital Management. With over $6.5B in assets under management, Brookstone was recently name the #1 Fastest Growing RIA by Financial Advisor Magazine.
As an Investment Adviser Representative, I find incredible joy and satisfaction in working with people to help them identify goals, manage risks, and achieve the type of long term results they are looking for. For more information, feel free to contact me using the information below.
Ronald A. Sneller, Jr. FICF, FSCP®, RICP®, RFC®
Registered Financial Consultant
Investment Adviser Representative
Ron Sneller is a fee-based financial consultant. A veteran of the financial services business for 10 years, he has helped clients with their mortgages, insurance, investments, and retirement planning during that time.
Through education, empowerment, and action, Ron helps his clients take back control of their financial life to give them more clarity, focus, and security. You can reach him at: ronald.sneller@snellerfinancial.com
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