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Michael Pope Blog post by Michael Pope

Return on Investment

What defines Return on Investment and how it differs for Property and other Financial Assets? And how do you align your expectation and the reality of the returns?

In previous articles we’ve been discussing the “outputs” that we are seeking from an Investment Strategy.  Most importantly, we will be looking for ongoing capital growth of our investment asset, i.e. that the value of the asset grows over time, a yield, or ongoing income stream, from the asset, e.g. dividends from a share portfolio or rental income from a residential property, or some combination of the two.  The total return received from an investment asset will be the combination of its growth in value over time and the yield it delivers along the way.

Depending on our investment objectives, we may be more focused on growth or be more interested in the yield, but either way, we will probably be seeking to get the highest possible total return from our investment.

In more recent articles, we have talked about the things that we will need to put in to an Investment Strategy and have looked at the different ways that money, time and knowledge will be required to implement an investment strategy and their impacts on the outcome of that strategy.

In this article, we look at what an investor should expect to get out of an investment in return for what they put in.

Most people think of Return on Investment in terms of the amount of money they invest, and clearly this is a critical factor  –  the more money you put into an investment, the more you expect to get out.  But this will not necessarily be a linear relationship.

Even with something as simple as a Term Deposit with a Bank, you may find that you will be offered a higher Interest Rate for a larger deposit amount.  If you are investing in Shares through a broker, a larger account balance may entitle you to a cheaper brokerage rate, although the percentage return on any given parcel of shares will be the same regardless of size, i.e. the dollar return on 1000 shares will be ten times that received on 100 shares.  Similarly, a larger account balance invested in managed funds may attract lower management fees.

 

Property is quite a different story.

It is unlikely that the returns on a portfolio of two $500,000 properties will be the same as the return on one $1 million property.  There are various reasons for this, but one key aspect is that there are fewer people in the market to buy million dollar properties than there are looking to buy half million dollar properties, and this affects the price due to the relationship between supply and demand.  This same relationship will impact on the capital growth and rental yield over the life of the investment.

Regardless of the investment asset chosen, it is clear that an investor will expect a return on investment of MONEY.

It is common to expect that the returns from an investment will be greater the longer that it is held, and this is a key factor when we are trying to take advantage of compounding returns.  It is less common to think about the level of return expected from an investment compared to the amount of time that it takes to establish and manage, but this is an important factor.  Does an investment that takes, say, an hour a week return 5 times as much as an investment that takes 10 hours a year of your time to manage.  Probably not, so it is important to consider which investment makes the most effective use of your time.

People who trade financial products, including shares, options, futures, etc. may spend anywhere from an hour or two a month to many hours a day analysing these products and submitting orders to buy and sell such products.  Clearly someone spending two hours a day should be expecting a greater return than someone spending two hours a month  –  they are expecting a return on investment of TIME.

Apart from time and money, any prospective investor will need to bring some level of knowledge to bear when selecting an investment strategy and investment assets.  Someone buying and selling shares or other financial products will need to have sufficient knowledge of different investment approaches to select one which is suitable to their objectives, and each approach will require that alternative investments be evaluated and compared, usually on a regular basis.  An investor who has spent many years learning and applying their knowledge should expect to get a better return than someone entering the market for the first time  –  they are expecting a return on investment of KNOWLEDGE.

Investing in property is an area where the effect of knowledge can be a major factor in the success of the investment.

Consider that an average Australian may buy up to six properties in their lifetime, and how much knowledge they will build up about buying and owning property, either through education or experience.  Contrast this with a Buyers Agent who spends their working life locating and purchasing properties for clients and may purchase up to six properties in a week.  Clearly there is going to be a significant difference in the level of knowledge that can be brought to bear to deliver a better investment decision.

So when evaluating different potential investment strategies, it is not just about what you expect to get out of that strategy as a return, it is also vitally important to understand what the selected strategy will require from you in terms of the amount of money, the amount of time and the amount of knowledge that you will need to contribute to establish and manage the investment.

Empower Wealth’s Personal Wealth Management Program includes a sophisticated tools which assist with gaining an understanding of your current financial position and determining what level of accumulated wealth will be required to deliver your desired lifestyle once you stop working for a living.  These tools will also allow you to see the effect of investment strategy decisions by modelling the effect of all the factors which influence the long term financial outcome of an investment, to give you the numbers you need to make an informed decision about your financial future.

If you would be interested in seeing how these tools and techniques could be applied to your own personal financial situation, please come and see us for a free one hour consultation.

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