Does your portfolio give you a ‘real’ return on your money?

Fsp Invest, 14 Aug. 2013

Tags: real return, portfolio, market, what is the real return, investments, nominal return, inflation, how to calculate the real return

When it comes to investing, there’s no point sinking your cash into investments that have no chance of giving you a ‘real’ return. If you don’t achieve a ‘real’ return you’re actually losing money. Let’s have a closer look at what a ‘real’ return is…

Investing in shares is all about averages, as Gareth Stokes in Fear, Greed and the Stock Market explains.

If you could buy a proportional amount of shares in every single company listed on the JSE – then your market performance would exactly echo that of the JSE All Share Index.

Of course, when the market is on a strong upward trend higher, you’ll be very happy with this ‘average’ return!

However, to gain this kind of exposure to the stock market, you’ll need millions of rand. And to secure an average return is simply not worth it when the market performs poorly.

You want to beat the market

If we look at the performances of various unit trust funds you can see the problem...

In 2007, there were plenty of spectacular results. Most funds rewarded investors handsomely.

However, a year later and the situation was quite different.

The top performing unit trusts in most sectors had negative returns, in line with the market performance.

Ideally, your investment goal should be for a winning performance on two fronts:
  • You should strive to outperform the market index.
  • You should strive to obtain a real return.

This means, your return on the equities portion of your asset allocation should beat the effects of inflation and taxation, at the very least.

What is the real return?

The real rate of return on your invested funds is the amount your investment actually grows after considering the effects of inflation and taxation.

Assume you’ve invested R100,000 in a money market unit trust fund, earning 10.25% per annum. Also assume you’re paying tax at the top marginal bracket of 40% and have no other interest earnings for the year.

The real rate of return on your investments

This is how you calculate the real return on your investment…

Real return = Nominal return - Inflation – Taxation

So for the example above…
Real return= 10.25% - 6% - 0% = 6.25%

The real rate is 6.25% compared with the nominal return of 10.25%.

This shows you how the real rate differs vastly from the nominal rate. It’s vital you know the real rate you’re getting.

So there you have it, the importance of knowing the real rate of return.

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