“Mike! Mike! Mike! I just made $100,000 on XYZ investment.”
“I’m up $75,000 on my home.”
“Hey Mike, I just sold this investment property and made $150,000.”
I hear these stories all the time. And, to be sure, anytime you make a profit, it’s a good thing.
But, how much you made is only one component to the quality of the investment. The other two include the total amount of your investment and the timeframe.
Case-in-point, if you earned $10,000, it could be a great investment if you only invested $10,000. It would be a pretty modest return if you had invested $1 million.
Likewise, if you doubled your money in a year, that would be a great return. If it took you 15 years, that would be less impressive.
That’s why percentages are what truly matter when it comes to understanding an investment’s return. If you double your money in a year, that’s a 100% return. If it takes 10 years, it equates to about a 7.2% annual return.
“Wait, what? Shouldn’t it be 10% since I’ve got a 100% return divided by 10 years?”
Unfortunately, compound interest can be a tricky calculation. It comes down to a mathematical formula called the Rule of 72 (don’t doze off). If you’re really interested in how it works, check it out here.
The same holds true for understanding the return of the markets overall. Focus on the percentages, not how many points an index is up or down. It really drives me crazy when financial media quote the Dow Jones Industrial Average in points instead of percentages.
A 300-point move is wildly different when the index is at 10,000 versus 30,000. So, the number of points up or down may feel impressive, but doesn’t really tell you anything.
I want each of you to be a successful investor and that means understanding how to properly evaluate an investment’s return.
Yes, you also have to evaluate risk, but that’s a lesson for another day.
If you want help, reach out.
This material is provided as a courtesy and for educational purposes only. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation.
The Dow Jones Industrial Average (DJIA) is a price-weighted index of 30 actively traded blue chip stocks. Indexes are unmanaged and do not incur management fees, costs or expenses. It is not possible to invest directly in an index.
This article contains a link to articles or other information that may be contained on a third-party website. Advisory Services Network, LLC is not responsible for and does not control, adopt, or endorse any content contained on any third party website.