It is Back to School time again! At this time, school kids refocus on the basics or the Three Rs (Reading, wRiting, and aRithmetic). Why they are called the three Rs, I will never understand. Nevertheless, today we want to focus on the basics.
One of the basics, I would like to discuss is “Real Return” verse “Total Return”. As investors for the long haul, we should focus on Real Returns and not be beguiled by Total Returns. Total Returns are what most people like to talk about. Can you recall being out at some function and someone starts to boast about their investment returns? They might say something like this,
My broker turned me onto the AxByCz Fund. She got me into the fund at $100 per share and now a year later it is worth $110 a share. She made me 10% just like that.
What your friend has failed to take into consideration is the following:
- Inflation
- Account Expenses/Fees
- Investment Expenses/Fees
Real Return
Ten percent is a nice return, but it is not your friend’s Real Return. A few items need to be accounted for to determine the Real Return. What was the impact of inflation over this period? If inflation is mild, it will not have a dramatic impact. On the other hand, if inflation is high it could clobber your Real Return like a runaway freight train.
One should also consider the Fees/Expenses you have on your account. Do you have to pay a yearly account expense if you do not meet a minimum balance or number of transactions? Did you take into account any transaction fees or the amount your broker is charging you? The more trading you conduct to generate your Total Return usually the more expenses you create.
If you own mutual funds, there may still be other fees and expenses to worry about. You will still need to adjust for 12b-1 fees, Front or Back-End Sales Loads, and etc.
To calculate your Real Return you take the Total Return and reduce it by the impact of Inflation, Account Expenses, and Investment Expenses. By knowing your Real Return, you can now determine the score of the game. I think we all want to know if we are winning or losing the savings game.
In understanding the basics of investing, it is important to understand that Total Return only tells you part of the picture. Knowing your Real Return makes you a savvy investor.
Do you know the Real Return on your investments from last year?
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Author
Isaac is a Fee-Only (no products sold) Certified Financial Planner® Practitioner. Isaac founded Stalwart Financial Planning with offices in Fayetteville NC and Durham NC. Isaac provides comprehensive planning and investment management services to individuals from all walks of life. Isaac can be reached by phone at 910-867-8464, or by email (iallen@StalwartPlanning.com). Visit him at Stawart Financial Planning www.StalwartPlanning.com.