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Don't Be Fooled by an Investment's Rate of Return

Tim Lemke — Fri, 08 Dec 2017 10:00:07 +0000

When you invest, you are looking for return. You want your money to grow over time, preferably at a rate that will allow you to achieve your financial goals.

An investment's rate of return can be a deceptive thing, however. The amount of money that an investment has made in the past isn't a guarantee of future returns. Moreover, these returns by themselves don't tell you a whole lot about what you are investing in.

Learning how to analyze an investment's returns — and understanding its limitations — will help you on the path to financial freedom. Just remember these key facts about an investment's return when examining it.

Short time frames don't tell you much

"Hey, this mutual fund went up 29 percent last year! Woo hoo!" That's great, but what did it do the year before? And the year before that? How has it performed over the last decade? Looking at the rate of return for a single year is not particularly useful, as any investment can have a hot 12 months. To get a sense of how an investment may perform in the future, it helps to have a long record of performance to examine. Fortunately, most brokerages and financial websites have comprehensive information on historical returns, so you're not simply looking at the performance of the last year.

It offers no information on the type of investment

It's great if an investment has a solid rate of return, but that should not be the only consideration when looking to buy shares. If you are buying a stock, you need to ask yourself key questions aside from just looking at performance. What industry does the company operate in? How big is the company? Does it operate internationally? If you're talking about a mutual fund, what is the investment mix? Answering these questions will help you understand whether you already own similar investments, and whether it makes sense to add them to your portfolio.

It's almost useless without context

Let's say you come across a mutual fund that earned a 9 percent return last year. You might think that is pretty good, right? Well, it doesn't look so good when you consider the S&P 500 returned 11.96 percent. Information on returns is only meaningful when it is paired with information about the broader stock market, comparable investments, and specific indexes. A small cap ETF, for example, should be examined alongside the Russell 2000 index. A mutual fund focused on technology should be compared to prominent technology indexes. Fortunately, most brokerage firms and financial websites do provide this, so it's important to analyze market returns using that context.

It does not always factor in all costs

If you purchase a mutual fund or ETF, a certain portion of your investment is taken in expenses and fees. While mutual fund returns are usually reported net of expenses, not every cost is included in this calculation. Many funds have sales charges and commissions (also known as loads) that you pay when buying and selling. Your brokerage firm may also charge a commission to execute the trade. This can reduce your overall return. The good news is that there are many good no-load mutual funds out there, and many can be traded without a commission, depending on the broker.

One more caveat regarding costs. Capital gains taxes will also reduce your balance when you sell. Be sure to factor in these costs when examining an investment's rate of return.

It does not offer detail on volatility

Let's say you have a stock that rose in value from $50 to $90 in five years. The annualized return on that stock is 16 percent. But that does not tell you whether the stock's performance has been consistent or wildly up and down.

For example, during that five-year period, that stock may have risen 20 percent, then dropped 25 percent, then risen 44 percent, dropped 10 percent, and finally rose 53 percent. That's pretty volatile, and may be outside the comfort zone of many investors even though the overall return is good. To get a better picture of the investment's performance, you need to look at the returns from each individual year, but even that offers no insight into price swings within any given year.

It can't answer the question "Why?"

An investment's rate of return may be the crucial piece of information you need to know before investing, but there's a lot that it doesn't tell you. Perhaps most importantly, it does not offer any insight into why an investment's price moved up or doing during a certain period.

Investment values go up and down for a variety of reasons, not all of them related to company performance. Perhaps a retailer saw its shares fall sharply during one quarter due to a series of natural disasters. Perhaps another company saw shares rise dramatically because of hype over its Super Bowl commercial. Returns on investment are crucial to know, but if you are an investor, it's important to do your own homework to understand why a price went up or down. Doing so will help you better understand how an investment may perform in the future.

It gives you no information on fundamentals

An investment's historical rate of return can give you insight into how it might perform in the future. But the company's actual financial performance may be even more important. It's not enough to just examine an investment's return. You should also look at company balance sheets, analyze earnings reports, and look at things like cash flow, debt, and price-to-earnings ratio. This will help you understand whether an investment's price is justified. Examples abound of companies that saw share prices skyrocket based on speculation although earnings weren't there to support it.

It tells you nothing about taxes

Let's say you invested $1,000 in a company stock and it earned an annual return of 9 percent a year over five years. That means you'll end up with $1,450 when you sell, right? Well, not exactly. Remember that unless you are investing in a tax-advantaged account such as a Roth IRA, the government takes its share when you sell. Assuming that you'll be taxed at the long-term capital gains rate of 15 percent, suddenly, that 9 percent annual return became something closer to 7 percent. Keep this in mind when trying to calculate how much money you'll actually walk away with.

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This article is from Tim Lemke of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

5 College Degrees Not Worth the Money

Damian Davila — Fri, 23 Jan 2015 18:00:08 +0000

Confucius advised people to "Choose a job you love, and you will never have to work a day in your life."

If you have a passion for a specific field, it can make sense to pursue a college degree. In theory, your degree should provide you a competitive advantage and make you more attractive to prospective employers. But with the average student loan debt for U.S. college graduates hovering around $29,000, it's important to pick a degree that not only fulfills your passions — but also makes sense financially. (See also: 8 Cheap Ways to Continue Your Education Without Going Back to School)

Here are five college degrees that don't make sense financially.

1. Sociology

Most people that enter the field of sociology have good intentions and want to help their fellow man. Unfortunately, sociology doesn't offer many well-compensated positions.

The U.S. Bureau of Labor Statistics projects that in 2022 there will be a total of 3,000 jobs available in this field. To put things in perspective: in 2012, there were 2,200 sociology jobs and approximately 17,000 sociology major graduates.

To complicate matters further, you often need at least a master's degree or PhD in this field to stand out among job applicants. Those who complete only a bachelor's degree are usually limited to lower-paying positions in social services. For example, social workers and chemical dependency counselors have median salaries of about $49,000 each.

2. Craft and Fine Arts

If you think that the term "starving artist" is just a myth, think again.

Let's assume a figure of $37,343 as the average cost for a four-year public liberal arts degree, and one of $121,930 for the same degree at private four-year college. The median annual salary for craft and fine artists is $44,380. This means that you would be better off skipping the degree and perfecting your craft on your own. Or, as The Economist suggests, putting that degree money into a 20-year treasury bill.

3. Education

Teaching is often referred to as one of the most noble professions. It's also often a low-paid one, making the decision to major in education a difficult one for students desirous of a strong return on their college investment. The average 20-year annual return on investment for educators is between -16.7% and 4.6%, depending on the college. So while it's tough to say an investment in such a noble (and necessary) career isn't worth the money, it's important to understand the financial implications.

While the median annual wage of $55,050 for a high school teacher may appear reasonable, it often comes with a low lifetime earnings ceiling. Few teachers earn above $80,000 per year, and many educators effectively work more than the standard 40 hours a week grading assignments, preparing lessons, and meeting with parents and school officials. On top of that, there are often volunteer activities and sports clubs.

If you're looking to make a career in education, it shouldn't be for the money. A study of the self-reported income of U.S. college graduates shows that close to 50% of those with the lowest 20-year net return on education are education majors.

4. Journalism

You have to love the irony: ABC News reports that the cost of a degree to pursue a career as a news analyst, reporter, or correspondent is $52,596, while the median pay is $37,090.

Assuming an annual repayment rate of 10% from that median salary, it would take a degree holder a total of 31.83 years to pay back her four-year journalism degree. Now that's some sobering news!

Given the rise of social media and DIY blogs, you might be be better off leveraging those tools to develop field experience, instead of spending time (and money!) on a journalism degree.

5. Anthropology and Archaeology

According to a report from Georgetown University, the starting annual salary for anthropology and archeology grads is around $28,000. There is room for income growth, but it plateaus at around $47,000 for undergrad degree holders.

To qualify for top-paying anthropology and archaeology jobs, you have to make a considerable investment in both time and money:

Most high-paying jobs require a two-year masters degree, some even a PhD.
PhD students typically spend 12 to 30 months doing field research for their dissertation.
International positions have additional academic and professional requirements.
Good jobs require work experience, but recent graduates face a 10.5% unemployment rate.

Even if you overcome all of these obstacles, there are will only be about 8,600 related jobs up for grabs by 2022.

Choosing a career is one of the most important decisions in your life. You shouldn't pursue a college degree based on money alone, but you need to have realistic expectations about the return on your investment in education. Your goal should be to choose a college degree that lets you do what you love… and not starve.

What are other college degrees not worth the money? Share in comments below.

This article is from Damian Davila of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Home Improvements That Pay Off

Darwins Money — Thu, 28 Jul 2011 10:36:11 +0000

As a homeowner, I'm often mulling over various improvement projects. A key consideration for many people who want to spruce up their homes, but think they may be moving in the foreseeable future, is what the payback is on particular upgrades. For instance, if there's something that's going to make your home look nicer and add back most of the value you put into the job, why not do it? Conversely, if there's very little residual value from your project, perhaps it should go lower on the list. (See also: Five Tips to Sell Any Home Fast)

To help sort out the various options (and perhaps give you some new ideas), the most comprehensive resource I've seen is the Remodeling Magazine Cost vs. Value Report. The report compares the average cost for 35 popular updates and then estimates how much of that upfront cost those projects retain at resale. While the methodology to arrive at these calculations may be tough to validate in today's volatile housing market, I believe the estimates to at least be directionally correct and helpful in sorting options.

The Best-ROI Home Improvement Projects

The study lists the following as among the best projects from a return-on-investment standpoint.

Steel Entry Door Replacement

The study reveals that you can actually have a positive ROI on this one, with 102% recouped on a $1,200 door. While it may not sound like the sexiest home improvement project, first impressions are lasting, right? The front door is the first thing people see upon entering your house, and most builder-grade doors aren't as nice as newer models you can upgrade to now.

Wooden Deck

With an average installation price of $11,000, the study estimates that at resale, you can achieve a 73% payback. Not too shabby considering you'll get a lot of use out of a deck anyway.

Minor Kitchen Remodel

This is the one I always hear about (from my wife!). We actually ended up upgrading our kitchen and beat the $22,000 price tag by installing our own cabinets. This is another project that ranks high on the list with a 73% recoup ratio.

Windows and Siding

Replacing the windows or siding yields returns over 70% as well.

Poor-ROI Projects

Projects that didn't rank very high on the list and lost about half their value at resale included following additions and changes to the home:

Garage addition
Bathroom addition
Sunroom addition
Backup power generator
Roofing replacement

Since we're staying in our home for the long-term, we don't rank the recoup value as high as some people might, but it's always in the back of my mind. After all, even if we don't plan on moving, maybe I can use this list to help talk my wife out of the next big project she has in mind!

What has your experience been with home improvement upgrades? Do you feel these recoup rates are accurate?

This article is from Darwins Money of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Is Your Marketing Campaigns Working?

JoAnne Berg — Wed, 15 Jun 2011 21:23:43 +0000

Link:

http://www.openforum.com/articles/is-your-marketing-campaign-working

Sales and marketing costs are among the largest expenses in running a business, yet they can be the hardest ones to evaluate.

How do you know if the time and money you are spending on marketing and sales is improving your bottom line? The truth is that ROI (return on investment) for marketing and sales spending is notoriously difficult to calculate. But it is possible to determine if your overall approach is working, and you can analyze your costs over time to get a picture of whether or not your efforts are effective. You can also track separate campaigns and see which ones result in a boost in sales.

To start with, let’s define these two terms.

Marketing is any activity that creates a prospective customer (a prospect).
Sales is an activity which turns a prospect into a buyer — a customer.

Analyzing the Effects of Your Marketing and Sales Spending

It is important to keep track of these two activities separately so that you know how much you are spending on each category. That’s the first step: set up your accounting systems so that you can easily see how much you spend for marketing, and how much for sales activities. If you run separate marketing campaigns, it’s wise to track the expenses of each one separately as well.

The second step is your sales reporting. It’s critical to be able to track your sales on a daily, weekly, and monthly basis, and compare them to last week, last month, and the same week and month last year. You will also want to compare them to your sales goals to see how you are doing. Otherwise, you won’t know if your numbers are going up or down. Those comparisons are critical.

Enter all these numbers into your trusty Excel to prepare a line chart of your expenses (marketing and sales separately) and sales revenue over time. Do you see a trend? When you ran that special campaign 6 months ago, was there a corresponding boost in sales revenue (it could be a bit down the line, say 30-60 days)? This will allow you to see any trends or patterns in sales revenue that is affected by your sales and/or marketing strategy.

Of course, increasing your sales is not the actual goal of your marketing efforts — increasing profits is the goal. So, it’s important to make sure that the sales you are gaining are profitable sales. To do this, add a line to your graph for gross profit, and you will get the picture very quickly.

What about the Value of Your Time?

For many of us, especially those of us in service businesses, our marketing and sales efforts are more personal — they are mostly made up of our time doing networking, communicating via social media, talking to potential clients, etc. There’s no “cost” for this reflected in our accounting systems — but it is a real cost, and it’s important to know if your efforts are effective.

Here’s a suggestion that has worked for many of my colleagues and clients. For 90 days, commit to recording your time and tracking how many hours you spend on each marketing and sales related activity.

Then, graph the number of hours that you spend each week for each category that you are active in. Don’t just lump it all together — break out networking, social media, etc. separately so you can see what is working and what is not.

On the same graph, record weekly billings, weekly new client proposals, or whatever metric is most meaningful to you, and compare that trend with you are spending your time. This is a great way to see if you are getting the most out of your efforts and will let you know where to spend more time and where to spend less.

It takes Money to Make Money

Marketing and sales efforts are a critical part of the success of any business, and they’re often one of your biggest costs. The trick is to spend time and money on the activities that really make a difference to the bottom line. Over time, these graphs can be invaluable in making sure you do just that.

This article is from JoAnne Berg of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

The Audacity to Waste Money for Better Finances

David Ning — Wed, 11 Aug 2010 13:00:10 +0000

I always thought it would be great if a screen door would work with the double french doors in my kitchen. That way, air could come in without the bugs having access to my house. Recently, I saw a retractable screen door at a friend's house. It would be the perfect solution I thought, until he told me it costs $700 to get it installed.

$700?! That's practically a decade's worth of air conditioning. I might as well just turn on the A/C any time I'm hot. But then a few days later, though the temperature was high in the kitchen, I opted to just bear with the heat since it was actually cool outside. The retractable unit obviously popped into my mind again. Since I was never going to turn on A/C anyway, is comparing it to the cost of running air conditioning just plain wrong?

This got me to think: Is there anything else that seems to be a waste of money at first glance but might not be so bad for certain types of people? Here are a few examples.

What's Worth the Waste

Financial advisers want 1 percent every year, and I've read loads and loads of articles about financial scumbags. Expensive, right? I get it. But for those people who can't keep themselves from themselves when the markets are at extremes, isn't that 1 percent a very smart price to pay? Buying a cup of Starbucks coffee every day may cost thousands of dollars a year, but isn't it better than feeling miserable all day?

I mean, some people end up buying a big ticket item every few months just because they aren't happy! And if you feel at peace, what's to say that you won't end up finding the motivation to start a side business that will make you that Starbucks fund many times over? Same with houses, cars, dresses and whatever else you fancy. If it motivates you, makes you happy, and you can afford to pay for it, what's so wrong about buying it? After all, money is meant to be spent, not hoarded.

What I Mean

Look. Most of us can probably use more of the "don't ever spend on anything" articles because we aren't saving enough. But in specific types of situations, what seems like a big waste of money is actually worth it. Think of it as an investment. Investment for your peace of mind, investment for your business, and maybe an investment for your happiness. Not every waste is actually a waste. Know yourself, and may your decision take you onto a smoother path to financial freedom.

This article is from David Ning of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: