Your Investment Expectations of Return
When you invest your hard earned money, how much of a return do you expect to get from your investment? Those who are new to investing will often say, “I want to earn a return of 50% to 100% on my investment—every year.” But is this realistic? What is a reasonable rate of return to expect on your investment? To find out, let’s take a look at a simple illustration of how things usually play out in the real world. Then we’ll come back to the question of what kind of a return you expect.
To begin our illustration, we will draw a horizontal line. Imagine that this line represents all investments known to man; from the lowest risk investments on the far left to the highest risk investments on the far right.
Now for our illustration, we will create some investment categories by drawing some short lines vertically across our long line. We will call these sections Low Risk, Medium Risk and High Risk.
If you were to invest in a high quality investment (as determined by a company’s credit rating), try to guess how much money a Low Risk investment would earn on average over a ten or twenty year period of time (you don’t have to invest for that long, but to fairly compare different types of investments, we want to look at average returns over a long period of time)? The answer would likely range from four to six percent. Now without looking ahead, guess how much of a return a Medium Risk investment would earn on average over a long period of time? A realistic answer would probably fall between six to eight percent. So what about a higher risk investment in quality companies? Over a long period of time, you would probably earn an average of around eight to ten percent.
These numbers assume that you are investing in high quality investments with good companies that have good reputations and good credit ratings. If you want to take your chances and shoot for a higher return you can do that, but that comes with added risk. Examples of these kinds of risks would be people speculating by buying shares in new companies or trading in the Commodity Futures Markets. These types of investments are very risky, and those who consistently earn higher rates of return in these markets typically only do so after many years of experience, research and learning exceptional discipline.
Many people loose a lot of money by chasing after exceptional rates of return. You can usually avoid this trap by carefully look into every investment you make and carefully consulting with those you trust before you make a big decision. The internet is a great tool for researching companies, individuals, and investment ideas to see what other people’s experiences have been. Don’t just look for the positives in potential investments—any salesman can give you a long list of those. Look just as hard for the negative side of every investment. It is often helpful to find people who have had bad experiences with the type of investment you are considering so you can avoid their mistakes. You should be able to find these kinds of people among your acquaintances, your family’s acquaintances, or online—but just remember to assess the credibility of the websites you glean information from.
This illustration isn’t finished. Make sure you see the other side of the coin in Your Risk Tolerance.