Rate of return - Question

I often get the question what is an adequate rate of return on my investment?

This question is impossible to answer. The average rate of return of the S&P 500 index since 1928 has been 10 %. That means that if you invested 1 dollar in the S&P index in 1928 you would have 43,900$ today. Not bad! Only problem is people are emotional and respond to stressful situations poorly. If you had invested in 1928 you would have gone through the great depression, WW2 and so on and surely taken your money out of the market which would then have affected your total outcome. So you can't surely expect a rate of return of 10 %. Whilst tinking about the rate of return you should also take into account the fact that while the ROI is going up risk is also going up.


In the graph on the left the illustration of risk vs ROI is illustrated. Here while you might be getting a higher ROI your risk is also going up. For example, stocks are seen as high risk investment and have given a 10 % ROI on investments. Therefore stocks are at a much higher part of the risk vs ROI line. The interest you earn from your bank deposit is probably low lets say 1 %. Then the risk taken by putting your money in the bank is very low too and so is at the bottom of the line illustrated. This illustration doesn't just show financial products but can also be used for other purposes such as for example your job. For a certain ROI you at the same time expose yourself to risk. Such as going from a normal working job to a manageurial position where you take on more responsibility which in turn is translated into risk.

Well, you could ask, what is the definition of risk and why wouldn't I want to take on more risk to get a higher ROI? The definition of risk is the chance that an investment's actual ROI will be different than expected. This could be that you loose all your invested capital or parts of it. In the job example going from a normal job to a manageurial job where the pay is higher, you have a bigger chance of loosing your job as a manager than as a worker due to the fact that you are held accountable for any mistakes made. If you take this to investing then investing in risky stocks may in the short term lead to a high ROI but in the long term will inevitably lead to high risk and to a depreciation of your investment.

If we take Warren Buffet for example, the best value investor out there. He was able to get an annual return on his investments by 20 %. Did his risk increase then? Here the difference between Warren Buffet and you is that he has spent countless hours studying the market. Knowing what is risky and what is not and has been able to find a very good risk vs ROI position. Warren Buffet may be one of the few who has been able to beat the market consistently or may just be an example of a phenomenon known as survivor bias, where there have been thousands of Buffet like individuals but just a few that have been lucky enough for their investments to return such a high ROI and these individuals have gained the spotlight shadowing the thousand of unlucky fellows. Other invesment gurus that have had high ROIs are Carl Icahn, 31 % ROI on his invesments and Micheal Steinhardt that had an average return of 24,5 %. These investors have all had different types of investment strategies but all these have found an optimization of both ROI and risk in their respective strategies.


We can clearly see that no matter what your investment strategy is, the goal of your invesment is to gain an optimization of your risk and ROI. This in turn will optimize your chances of gaining a high ROI on your investments and optimize your luck. In turn, luck plays a major role in all investment strategies. As luck plays a major role in investing your role as the investor is in optimizing as to gaining the highest amount of luck which requires planning and preparation. We might not know where the market is heading to and educated guesses could be made about every direction but the one thing all investors can do is be prepared and act consequently and intellegently.