Wednesday, October 15, 2008

Average Annual Return Means Dick....

The average annual return on any financial document means dick what you really need to look at is what was the yield. Many people forget that these are completely separate items for example.

I am going to invest a $5,000.00 and watch it grow in a high risk mutual fund over four years.

Year.. Return.... Amount
1..... 100%..... $10,000.00
2..... -50%..... $5,000.00
3..... 100%..... $10,000.00
4..... -50%..... $5,000.00

My average annual return is (200-100)/4 = 25%
My Yield is.....drum roll........ 0!

Which number is on the prospective?

Which number do you actually car about?

If you factor in the time value of money with inflation and fees from the fund you would actually have a negative yield. But since this example used semi unrealistic numbers in the rates of return to simplify the example, it should also leave out the additonal detail.ical.

So next time you are sitting with a financial planner or looking at a fund say that is nice rate but what is the take home yield after Inflation and Fees.... after all that is what you really care about.

You will start to notice funds that might not have high rates of return every year but with dividends, cash flow, etc. they will have a yield that is much higher then those funds you are investing in with much less risk.


Rocketstar said...

I love me some great yielding stocks.

scargosun said...

You want to also make sure that your financial person is aware of your risk tolerance. If you are conservative, the investments with good dividends are a great way to go but if you are moderate to moderate aggressive, you need to look at investments with a little more risk. Not saying you need to go for the high risk one mentioned but more diversification can help.

Brian in Mpls said...

I am actually starting to be the opposite screw risk. I have not seen any proof that the more risk you take the more money you actually make.

(If you have any proof please forward it to me I would love it for a thesis I am working on)

I am starting to lean toward more investments that are securitized to assets vs unsecured debt which is the riskiest.

Robin said...

You lost me at dick.

Ma said...

I only wish I had extra money for investing