Before you invest your money, you’re probably wondering how much you’ll make. This is known as the rate of return or return on investment. The return is expressed as a percentage of the total amount you have invested. If you invest $1,000 and get back your original investment, plus another $100 in interest, you have earned a 10 percent return.
However, numbers do not always tell the full story. You should also consider how long you plan to hold the money invested, how your investment options have performed historically, and how inflation will affect your bottom line.
Key return on investment metrics
When you’re trying to get the best return on your investment, you’ll likely be sifting through a large amount of data. A good place to start is to look at the past ten years’ returns on some of the most common investments:
- Average annual return on supplies: 12.8 percent
- Average annual return on international shares: 4.9 percent
- Average annual return on bonds: 1.4 percent
- Average annual return on gold: 3.4 percent
- Average annual return on property: 4.8 percent
- Average annual return on 1-year CDs: 0.42 percent
CD interest rate data comes from internal bank interest rate averages.
What is a good return on your investment?
There is no simple answer to defining what constitutes a good return on your investment. You need some additional context about the risk you’re accepting with the investment and the amount of time you need to reap the rewards.
Let’s say you need a ride to the airport. It’s still a 30 minute drive, and you’re a bit behind schedule. A friend promises to get you there in 15 minutes, but the journey involves driving 100 miles per hour, running red lights, darting in and out of traffic, all the while fearing for your life. Was that 15 minute “return” of your time really worth the drive that came with the risks of accident and injury? Probably not.
Now think of a real financial example: a 2 percent return. This may not sound impressive, but let’s say you earned that 2 percent in a federally insured high-yield savings account. Then it is a very nice return, because you did not have to take any risk. If that 2 percent figure came after you spent the past year following Reddit forums to chase the latest meme stocks, your returns don’t look so good. During any major valuation swing, you had to accept a large amount of risk, while probably losing a lot of sleep.
Long-term versus short-term investments
When it comes to investing, the adage “time is money” applies: the longer you leave your money invested, the more you can generally expect to make. Long-term investments – ideal for retirement and wealth building – offer higher returns, but you’ll have to deal with their ups and downs, while short-term investments are best for immediate needs, such as an emergency fund or a down payment on a house – are typically safer with a lower average return.
Examples of long-term investments
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Stocks: From recent IPOs to blue chip stocks, investing in stocks gives you the chance to reap the rewards of a company’s growth. Keep in mind that you will also have to bear the company’s losses during tough times and bad quarterly results.
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Real Estate: Whether you buy a home to live in or buy another property to rent out, real estate can be an attractive long-term investment. Home prices tend to rise over time, although they are not immune to boom-bust cycles.
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Target Date Funds: Aptly named, these funds invest in a mix of asset classes (stocks, bonds and other opportunities) with a specific maturity date and automatically adjust your risk profile as the target date approaches. These are especially suitable for the long-term goal of retirement.
Examples of short-term investments
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Savings accounts: Putting money in a savings account can also pay off with some extra interest. You won’t make much because you have the option to withdraw the money at any time and enjoy the protection of FDIC insurance, but some online banks pay above-average rates.
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Certificates of Deposit: Traditional CDs are among the lowest risk investments. By agreeing to keep your money locked up for a certain period of time (for example, six months or eighteen months), a bank or credit union pays you a slightly higher interest rate than you could get on a savings account.
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Treasury bills: The U.S. Treasury issues bonds to help finance the government’s spending needs, and Treasury bills have the shortest maturities: as little as four weeks and as long as a year.
What if your investment is below average?
If your investments don’t meet expectations, follow one essential rule: don’t panic. In a year, the stock market could rise 14 percent. Two years later, this figure could have fallen by more than 35 percent (as in 2008). Earning the average means taking the good with the bad, leaving your money invested and reinvesting all distributions – even if the index underperforms.
Stocks, real estate and other higher-risk investments can generate negative returns in the short term. However, over longer periods of time, these investments can make up lost ground and generate the higher return on investment that caught your attention in the first place.
Insight into the impact of inflation on your returns
You should also pay close attention to the inflation rate to get an accurate picture of what your investment can actually return. If you earned a 5 percent return on an investment at a time when inflation has risen 5 percent, your post-inflation, or real return on your investment, is zero.
Cash investments often track inflation, or at best keep pace with inflation. If you keep all your money in CDs and a savings account for decades, the amount of money in your account will increase, but the purchasing power of that money will likely shrink.
For long-term investment goals such as retirement, a heavy allocation to stocks – especially in the early part of your professional career – is a proven way to beat inflation and create wealth. And in times when inflation is heating up, it’s important to understand what the best investments are to hedge against that declining purchasing power.
In short
“What is a good ROI?” has no ready-made answer. To accurately understand how your returns stack up, you need to have a holistic view of the bumps and risks along the way. And remember, when you talk about investing, it means looking at the big picture and all the long-term opportunities in front of you – not trading based on the latest news and movements in the market. By diversifying your portfolio across different assets and holding those assets during difficult periods, you can optimize your return on your investment based on the risks you are willing to take.
— Bank interest Rachel Christian contributed to an update to this story.
