What is a Good Investment Return? Not so simple.

In order to know if you are on track with your investments, you need to know what is a good investment return.  This might seem to be an easy task but as you’ll see it’s a little more complicated.

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 (assuming you didn’t make any withdrawals during the period). Simple.

But that doesn’t tell you the whole story. Just knowing that your portfolio returned 7.35% last year for example just tells you what the return was in a vacuum. You still don’t know if 7.35% is a good return for your specific portfolio during that specific period.  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.  Part of knowing how well you did is to compare your results to other similar portfolios or indexes over the same time period.

And while we’re on the subject of time periods, lets dig a little deeper.  People evaluate their portfolios and holdings over many different time periods. But they sometimes compare similar funds over different periods and that’s a mistake.  For example, lets say your fund made 5% over the first 5 months of the year.  Does it matter that a similar fund made 8% for the last 12 months?  No.  That’s because your time periods are different.  This may seem elementary to you but people make this mistake all the time.

And when it comes to time, how long a time period should you consider when you determine whether or not you are getting a good return?  Some people make decisions based on what’s happening today.  Others look at the portfolio each month and make decisions.  Still others look at the yearly results.

Personally, I look at differently monthly intervals to determine if a fund is working or not but everyone does it differently.   And while I compare funds based on monthly (and longer) performance, I look at many years and decades when I evaluate investment styles and methods.  So at the end of the day, it really depends on what question you are trying to answer. Right?

To make an analogy, lets say you like Toyota cars because of their very long-term track record so your “method” is to buy Toyotas.  But you might pick one Toyota over another based on what the model offers that particular year.  Make sense?  Good.

Your Financial Goals

In my opinion, the ideas presented above are important but not crucial.  You also should consider whether or  not your current portfolio is helping you achieve your long-term goals.   Let’s assume you have all your money in the bank and you earn 1.5% on your CD when everyone else is earning less than 1%.  If  you compare your CD to your friends’, your investments are doing great.

But if you need to earn 4% on your money in order to achieve your goals, that “great” CD isn’t doing well at all.   Right?  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.  That’s why it’s really tough to evaluate your investment holdings if you don’t have an investment plan.

Your Investment Allocation Choices

Another 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?