What is a Good Return on Investment?

CATEGORIES: Investment Planning

what is a good return on information

What is a Good Return on Investment?

Sometimes the most useful advice a person can get comes from asking the right questions. When it comes to investing, everybody wants good advice. But all too often – they ask the wrong questions. “Can I get double digit returns from now until retirement?” is not a particularly helpful question. Neither is: “I had this great stock back in the 1990s … Can you find me something that will earn the same levels of return?” A much better question would be: “What is a good investment return – for me?” This will put you on the path to finding a helpful and useful answer.

Past Precedent is Not Reliable for Future Investment Returns

You’ve seen the statement as a disclosure item on investment documents: “Past precedent is not a reliable indicator of future returns.” Any discussion of a good investment return has to start from the premise that it has nothing to do with what a “good return” was last year, ten years ago, or even the average annual return for the last 25 years. Sure, you can look back at performance and say something like “ABC Fund did great last decade – the Russell 3000 index was flat and this fund returned 5% on an average annual basis”. But those numbers are situational… Sometimes investment advisors will toss around the phrase “long-term historical average” and show you the upward-sloping chart of the Dow Jones Industrial Average from its inception in 1896 to the present. Still, there is no reason to believe with any certainty that information on that chart can tell you what to expect as a “good” return over your proposed investment time horizon. Empires rise and fall over hundred-year periods. The future is inherently uncertain.

Start With the Basics and Build From There

Put simply – a good return is what you need to meet your financial objectives, taking into account inflation expectations and the liquidity events (e.g. home purchases, kids’ education) that will subtract from your earnings over the years. Institutional investors, like foundations, often express their return objectives in the form of real returns, for example “annual rate of inflation plus 2%”. This is also helpful because it is then relatively straightforward to run a multi-year analysis of your financial needs (at today’s prices) and see what real return will cover those needs.

“Return” on Investment Is Never Complete Without “Risk”

A good return can never be expressed without a corresponding expression of risk. Sure, those dot-com stocks in the late 1990s produced sky-high returns, but the level of risk was commensurately high (as anyone who was holding shares of Pets.com in 2000 knows).  A portfolio of bonds mimicking the Barclays US Aggregate Bond Average may only rarely approach double-digit annual returns, but it will just as rarely find itself in negative territory. Risk and return are two sides of the same coin. Investors use the term “efficient frontier” to describe the best set of returns available for a given level of risk. Bear in mind that when we talk about risk in this sense, we mean the extent to which returns are likely to vary from an average outcome.

Not Your Neighbor’s “Good Return” on Investment

We humans are social creatures and are prone to measure our own success in terms of others. One of the perennial pitfalls of investing is the Cocktail Party Syndrome. You hear your neighbor talking about that great new can’t-miss thing he just bought into, and suddenly your balanced portfolio of blue-chip equities and investment grade corporate bonds is looking pretty frumpy by comparison. Avoid this dangerous syndrome at all costs! The return that is good for you is based very specifically on your own life situation and a prudently diversified portfolio with carefully-selected assets that fit your specific risk tolerance.

Post a comment and share your thoughts on what a “good return” means to you.

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About the Author

Katrina Lamb is a CFA for Jemstep. She has over 25 years experience in economics, finance, international development and management strategy, with a strong focus on global markets. She provides a voice of clarity, logic, and reason in an environment characterized by high uncertainty.

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4 thoughts on “What is a Good Return on Investment?

  1. Additionally and especially, don’t compare your rate of return to that of your neighbor, or anybody else, who had a significant position in Apple over the last one, two, or three years. or months.

  2. What is a Good Investment Return?

    I read the whole story and am still waiting to find out what a good investment return might be.

    Surely you can’t think all those platitudes answer the question.

    • Hi Dave,

      It’s true that the answer is not definitive, but that is the point of the post.  There is no “one-size-fits-all” definition of a good return.  Here is very simplified broad example: a good return for someone in their 20s would not be the same as a good return for someone in their 50s.  This is because they have very different investment objectives and have distinctly different financial situations to consider.  Because risk and return are tied fairly close together, investors in their 50s are not in a position to take on the risk that would likely be needed to achieve the returns that someone in their 20s would consider a good return.  Put simply the primary objective of the 20-something would be growth, while the objective of the 50-something would be preservation.  That difference in goals would mean very different things for each investor in terms of a “good return”.

      Hope that adds some clarity.

  3. You are so spot on!
    Your age, you debt, you life style, your income, your risk tolerance.
    These factors will determine you investment style. Not Cramer, or the other talking heads on TV.
    How soon will you need your investment money?

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