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What Is Considered a Good Rate of Return on Your Investments?

Reasonable Expectations Can Help You from Taking on Too Much Risk


What Is Considered a Good Rate of Return on Your Investments?
One of the main reasons new investors lose money is because they chase after unrealistic rates of return on their investments, whether they are buying stocks, bonds, mutual funds or real estate. This happens due to a lack of experience. Most folks just don’t understand how compounding works. Every increase in percentage profit each year means huge increases in your ultimate net worth. For example, $10,000 investing at 10% for 100 years turns into $137.8 million. The same $10,000 invested at only twice the rate of return, 20%, turns into $828.2 billion. It seems counter-intuitive that the difference between a 10% return and a 20% return is 6,010x as much money.

Answering what is a “good” rate of return on your investments is probably easiest if we examine the nearly 200 years of data from Ibbotson & Associates, a data research firm that tracks financial market history. The first thing we need to do is strip out inflation. The reality is, investors are interested in increasing their purchasing power. That is, they don’t care about “dollars” or “yen” per se, they care about how many cheeseburgers, cars, pianos, computers, or pairs of shoes they can purchase.

Looking through the data, we see rate of return vary by asset types:

  • Gold – Typically gold hasn’t appreciated in real terms over long periods of time. Instead, it is merely a store of value that maintains its purchasing power. Decade-by-decade, though, gold can be highly volatile, going from huge high to depressing lows or visa versa, making it far from a safe place to store money you may need in the next few years. To illustrate how gold itself very rarely changes in value, it is the things around gold the fluctuate, I once researched fifteen years of gold prices in various currencies on my personal blog for my own benefit.
  • Cash – Fiat currencies are designed to depreciate in value over time. In fact, $100 in 1800 is worth only $8 today, representing a loss of 92% of value. Burying cash in coffee cans in your yard is a terrible long-term investing plan. If it manages to survive the elements, it will still be worthless given enough time.
  • Bonds – Historically, good, quality bonds tend to return 2% to 4% after inflation in normal circumstances. The riskier the bond, the higher the return investors demand.
  • Business Ownership (Including Stocks) – Looking at what people expect from their business ownership, it is amazing how consistent human nature can be. The highest quality, safest, most stable dividend paying stocks have tended to return 7% in real, inflation-adjusted returns to owners for centuries. That seems to be the figure that makes people willing to part with their money for the hope of more money tomorrow. Thus, if you live in a world of 3% inflation, you would expect a 10% rate of return (7% real return + 3% inflation = 10% nominal return). The riskier the business, the higher the return demanded. Someone would want a shot at double digit or triple digit returns on a start-up, for example, because the risk of failure and wipe out are much higher.
  • Real Estate – Without using any debt, real estate return demands from investors mirror those of business ownership and stocks. The real rate of return for good, non-leveraged properties is roughly 7% after inflation. Since we have gone through decades of 3% inflation, over the past 20 years, that figure has stabilized at 10%. Riskier projects require higher rates of return. Plus, real estate investors are known for using mortgages, which are a form of leverage, to increase the return on their investment.

As you can see, if you expect to earn 15% or 20% compounded on your blue chip stock investments over decades, you are delusional. It isn’t going to happen. Basing your financial foundation on bad assumptions means you will either do something stupid by overreaching in risky assets or arrive at your retirement with far less money than you anticipated. Neither is a good outcome so keep your return assumptions conservative and you should have a much less stressful investing experience.

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