Why chasing rate of return on your investments is not a good idea?

The media, your financial advisor and maybe even your best friend talks about the rate of return (ROR) that you should be getting in your portfolio and very often everything going forward is based on that desired rate of return.

The problem is that when you project future values based on some potential expected rate of return you most likely will not be a good steady saver.

That means that when you are saving for your kids’ college and when you are putting aside money towards your own retirement the projections are very often done using a historically high rate of return.

return-on-investment

There is nothing wrong with having a desire and nothing wrong with having a plan that works towards getting historical rates of returns.

There is though a problem when you use these expected rates of return when you build your financial plan and when you do analysis around how much you should be saving on a monthly basis.

The problem is that when you project future values based on some potential expected rate of return you most likely will not be a good steady saver.

Let’s take an example:  If someone were to retire in 20 years and they were told that they could either save $1,000 a month with an expected ROR of 8% of they could put aside $1500 a month with the expectation of a 4% annual ROR (assuming same output at the end) this individual will most likely gravitate towards saving less and thereby taking on unnecessary risk within their financial plan.  The problem is not the expected rate of return but the problem lies within the expectations of that return which then leads to the consumer saving less than desired.

how-to-invest-to-get-better-rate-of-return

A better financial plan looks beyond rates of return and focuses on adequate savings rate and focuses on having an understanding of how savings rate is more important than chasing rates of return and at the same time still invest with the objective to maximize the overall rate of return.

It is not the rate of return within a single portfolio that should be analyzed but the rate of return that is obtained within the overall financial plan and that means that one should look at all parts of a plan from the protection portfolio, debt management, taxes and assets.

Written by CreativeNurse team

2016-23963  6/18