16 Nov Return of your money vs return on your money
It is easy in today’s environment to concentrate on the returns that a particular investment opportunity may produce.
We are all constantly bombarded with information on the potential returns that different investments should provide. Whether on the Tube, where spread betting seems to be the answer to getting quick easy high returns, on the internet or over the dinner table! In fact, the dinner table can be the worst as we succumb to the investor’s equivalent of ‘keeping up with the Joneses’ and leave the table thinking that the return we are getting is not as good as our friends’.
We tend to focus on the potential positives and suffer from over confidence in our, our friends’ or an investment’s ability to provide a ‘great’ return.
It is rare that we actually consider what a great return is i.e. what does X%pa actually mean for us apart from potentially more money at some point in the future? Discussing what constitutes a great or reasonable return would take up more time than I have here, but I would define a ‘great’ return as:
‘the return you need to achieve to stand a reasonable chance of meeting the cost of your financial goals, which should be based on what you want to achieve in life’
However, assuming you are investing funds that you have worked hard to accumulate (or if you are lucky someone else has worked hard to pass on to you) then surely you would be better focusing on preserving your money first?
Will Rogers, the American humourist and entertainer is attributed as saying “I am not so much concerned with the return on capital as I am with the return of capital”. I think he may have a point.
Obviously, we should all still be concerned with the returns our investments are getting, whether they are cash savings or stock market investments, however perhaps the most important starting point when reviewing any investment idea or opportunity is to assess how you will obtain your money back and in what timeframe.
I don’t just mean getting the capital back at some future date, although knowing this is a good starting point. It often surprises me just how little investors truly know about exactly how they might withdraw their capital from an investment.
I am also referring to the long term preservation of capital in real terms i.e. when you finally receive your capital back, what is the likelihood of it having the same purchasing power as it does today?
Inflation and longevity (how long your money has to last) risks are the two most important risks most of us should be focusing on yet most people only focus on the potential short to medium term nominal returns of an investment.
Most information on investments will try and provide you with some information around volatility or potential loss of capital but this is usually based on a short period of time (over the last five years is common) and even if you do focus on this, it is unlikely to be repeated over the next five years and may not have any bearing on your investment time horizon. More importantly you have no idea how that potential loss of capital will affect your objectives.
Perhaps we would be better served by taking a step back from all the noise around investments and consider the following:
- how am I going to get my money back;
- if and when I do get my money back is it likely to be the same in real terms;
- if there is a risk to getting my money back is this adequately compensated by the potential return;
- what is the implication on meeting my objectives if my capital is lost;
- can I sleep at night knowing that there is a risk of losing the funds I have invested?
If you conclude that you cannot risk losing any of your capital, then you will need to invest accordingly and accept lower returns. There is nothing wrong with this and it is likely to just mean that you may have to re-adjust your long term objectives or save more to decrease the return you need to reach them.
When you create and review a financial plan based on your objectives and using reasonable assumptions, all of the above are considered rather than simply chasing the ‘best’ return on your money.