The goal of investing is to get the maximum return with minimum risk in the shortest time. There are no absolute numbers that constitute a "good" or a "bad" rate of return -- the return should always be viewed in the context of the risk that an investor must take to achieve it. Since every investor has a different risk tolerance level, what constitutes a "good" return depends on how much risk an investor is willing to take to achieve it.
The starting point is to establish the current risk-free return. Bank savings accounts and short-term certificates of deposit (CDs), money market funds and Treasury bills are considered risk-free. If an investor is happy with the return those instruments provide, he does not need to take risks and the return he gets is "good" in his opinion. If he wants to get a better return, he must take risks.
An investment's upside potential must always be compared to the potential downside. If investment A's upside potential is 20 percent but the downside risk is 50 percent, its potential return is not as good as that of investment B, which offers an upside potential of 10 percent but has a downside risk of only 5 percent.
Liquidity refers to how fast an investor can convert an asset into cash without undue loss of principal. The more liquid an investment is the more control an investor has over the potential risks. For example, an investor may consider a stock that has the potential to appreciate 50 percent but could also decline 50 percent. An investor could decide to buy a stock for a 50 percent upside but set a "stop loss" of 5 percent to cut his losses if the stock moves against him. A 50 percent upside vs. a 5 percent downside is a good return. On the other hand, a fixed annuity can offer a guaranteed return of 5 percent, but if an investor needs the money in an emergency, it may take him a long time to get it, and the insurance company may charge him a surrender penalty of up to 10 percent. A 5 percent guaranteed upside vs. a 10 percent potential downside is not a good return.
An investment may offer an attractive return but the minimum required amount may be high, subjecting too much of an investor's capital to the same type of risk.
Rate of Return
Investors annualize returns to compare them. For example, if an investment returns 30 percent over a three-year period, its annual rate of return is 10 percent. Obviously, the higher the rate of return, the better -- provided the investor has properly factored in the above risk considerations.
- "The Alchemy of Finance"; George Soros; 1994
- "The Battle for Investment Survival"; Gerald M. Loeb; 2009
About Roth IRA Rates of Return
Roth individual retirement accounts (IRA) provide a very practical tax shelter for retirement savings, and the best part is that the owner...
How to Annualize a Percentage Rate of Return
A percentage rate of return measures the percentage of an investment that it generates as profit over a certain time period. If...
How to Pay an Investor
Investor agreements are usually pretty flexible. Most experienced investors understand that businesses sometimes need a grace period to get their business off...
How to Calculate Investment Rates of Return
Looking at a year-end statement that shows the "rate of return" on investments only tells part of the story on return. Whether...
How to Choose Diversified Investments Using Percentages
All investors should have a specific plan for portfolio diversification. The key to determining the percentage allocated for each asset class is...
What Is Considered a Good Gross Margin Percentage?
Gross margin, sometimes referred to as gross profit margin, is the amount of profit realized after the subtraction of cost of goods...
What Is a Good Dividend Yield?
Dividend yield is the amount of the dividend divided by the current stock price. The simplistic answer to the question of what...
What Does a Low Percentage Return on Assets Mean?
Companies use the return on assets (ROA) ratio to determine whether they are earning enough money from capital investments. These investments might...
Safest Investments With Best Rate of Return
No investment is completely risk-free, though some are certainly safer than others. When looking at the risk/return ratio in investing, the general...