Rate of Return
Do you know the rate of return on your investments? Have you ever calculated your total return? In my experience, most investors don't know what they earn on their money. Of course, I often hear about winning stock trades – never the losers, nor do people tell me how much they allocate to their trades. A 10% gain on a million-dollar investment is more impactful than one where you only commit $100.
I recently watched a Bitcoin evangelical promote the compounding rate of return for the popular digital currency. He was touting annual gains of 200% to the host and millions of TV viewers as if it was normal. At 200%, a $100,000 investment will be worth $5.9 billion (with a B) in ten years! If you earned 200% for twenty years, you'd be worth $348 trillion (with a T) – totally normal. After thirty years: $20,589,113,209,464,900,000, or $20 quintillion. Regulators would throw me in jail if I touted annual returns of 200%.
Rates of return matter, and being aware of what you earn is essential. Your money doubles every ten years at 7%. If you make less than 3% per year, inflation will wipe out your gains. Risk and reward are connected. A portfolio of stocks earns more than a portfolio of bonds, but the risk level is higher. The 100-year return for stocks has been 10%, but there have been several years of negative performance and numerous market crashes. During the same time frame, the one-month US Treasury Bill never lost money – not one negative year, but it generated a paltry average annual return of 3.3%. Since 2005, the S&P 500 is up 224%, while short-term bonds have increased by 5.75%. The S&P had several corrections, including a 51% crash in 2008 and a 30% decline last year; bonds barely budged.
A financial plan can give you a glimpse of your future. Most planners can review your performance and risk level to determine how much of both are needed to reach your goals. If you're far from your target, owning more stocks is recommended. A sizable allocation to equities will allow you to generate higher rates of return. If you have more than you need, allocating a bigger percentage to bonds can help maintain your wealth.
A balanced portfolio of 60% stocks, 40% bonds produced an average annual return of 9% since 1926. It lost 44.5% in 1931, but it rebounded 82% in 1932, and 36% of the time, it lost money. However, the portfolio never lost money on rolling 10-, 15-, and 20-year periods.
Balancing risk and return is part art and science. Allocating too little to stocks can negatively impact your wealth. If you're young, stocks will benefit from your time horizon. If you're retired, investing in stocks can help you maintain your purchasing power. Investing too conservatively at any age can have dire consequences to your wealth.
My best investment, so far, has been Amazon. I bought a few shares for my daughter's education account in 2005, and it has generated an average annual return of 31%, or 6,647%. It's not 200%, but it has helped us pay for college.
"In investing, what is comfortable is rarely profitable." — Robert Arnott
March 10, 2021
Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM's custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.
Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren't suitable for every investor.