What Is a Good Percentage Rate of Return?

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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.

Risk-Free Return

  • 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.

Risk/Reward Balance

  • 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

  • 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.

Minimum Investment

  • 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.

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References

  • "The Alchemy of Finance"; George Soros; 1994
  • "The Battle for Investment Survival"; Gerald M. Loeb; 2009
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