In order to know if you are on track with your investments, you need to know what is a good investment return.
But contrary to intuition, this isn’t as easy as it sounds.
How to Determine What a Good Investment Return Really Is
First, lets get clear on what your return is. You calculate this by comparing what you started with to what the end result is. Simple.
But that doesn’t tell you the whole story. Just knowing that your portfolio returned 7.35% last year just tells you what the return was in a vacuum. You still don’t know if 7.35% is a decent return for your specific portfolio. This is important because you need to make sure you take on as little risk as possible in exchange for that return. What if other people made similar returns but with half the risk? You see where I am going with this.
Your Financial Goals
One way to look at your investment returns is to compare them to your financial goals.
If your long-term plan requires a 5% average return and you have been averaging 6% you are doing fine. Of course this assumes you know what your goals are, you know how much you need to earn on average in order to reach those goals and what your average returns have been.
Your Investment Allocation Choices
A second way to weigh how well your investments did is to compare your returns to how well the indexes did that represent your allocation choices.
For example, over the last 50 years or so stocks have returned about 9% per year while bonds returned about 5% per year. If you had a portfolio split 50/50 between stocks and bonds, your average expected rate of return would be the average of 9% and 5% which is 7%.
If your average return is 7.35% you would be doing well.
What is the Best Way to Determine a Good Investment Return?
In my opinion the best way to know if you are on track with your investments is to make sure you are achieving your financial goals. It doesn’t matter if you had “low” investment returns if those returns met or exceeded your financial goals. Likewise a phenomenal return that doesn’t meet your objectives isn’t so phenomenal.
How do you know if you are doing well or not with your investments?