Before you invest, you’ll want to consider how much money you are going to make. Investors typically use ROI as a measure of performance, to gauge the value of a security and to compare different investments equally. Often, you'll have to adjust your expectations based on the length of time you are investing and the rate of inflation in the economy. You can use the calculator on this page to find out how much you’ll earn from an investment, by answering a few simple questions. If you continue reading, you can learn about the different ways to measure returns, and why each is useful.
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Your investment returns
There are generally three ways to make money from investments, depending on the type of asset you buy into. Your earnings can come in the form of interest payments, dividends, or asset appreciation (aka capital gains). It is important to know the differences as each payout has different implications. Read about each below:
Interest. When you put your money into a savings account, you can earn some modest interest on your holdings. If you buy treasury notes (or bills), CDs, bonds, or annuities you’ll get interest payments until the fund reaches maturity. Typically, interest is taxed at the same rate as your earned income, with a few exceptions. You can get tax-free yields by investing in Municipal bonds, or get a federal exemption investing in treasury bonds.
Dividends. When investing in stocks and money market funds, you can get dividend payments. If a company makes a profit, an after-tax portion can get paid to the investors. Typically, dividends get a preferential tax rate since the tax obligation is split between the company and shareholder. Research done on stock returns by researchers Fama and French concluded that dividend stocks tend to outperform non-paying stocks by about 2%. You can read the original paper from 1988 here, or a meta-analysis on dividends and investment returns from 2007, here.
Capital gains. Investments usually result in some form of capitals gains. When you buy stocks, mutual funds, bonds, or real estate and make a profit from selling the asset, the revenue is capital gains. Securities held for longer than a year are given a special tax status over securities held less than a year.
Capital Loss. By contrast, if you lose money on an investment, it’s called a capital loss. If you experience capital loss, you can use your losses to balance out your taxes. For example, let's say that you lost $50,000 from an investment this year but gained $100,000. Your net gains would only be $50,000 on your tax form. If you have a net loss, you could use $3,000 each year to reduce your taxable income (or offset future capital gains).
Gains in retirement accounts. Qualified plans like 401k and 403b earn interest, dividends, and capital appreciation. Regardless, you won’t pay any taxes until you take money from the account. In exchange for the tax-deferred investment growth, your earnings get treated (and taxed) as ordinary income, as opposed to long-term capital gains.
Knowing the difference between returns is only the first step. To compare your options equally, you’ll have to estimate your investment returns. A CD won’t provide the same returns as a stock, and alone may not help you reach your investment goals.
How to calculate ROI
ROI is very easy to calculate and is a very versatile measurement of investment performance. Investors will generally use time-weighted returns and dollar-weighted returns to gauge their investment performance.
Time-weighted returns. This is the return produced by an investment, independent of withdrawals or contributions. It can measure the fund’s rate of growth over a defined period of time, such as monthly, quarterly, or yearly. The returns for each period are based a geometric growth algorithm using the amount of money in the portfolio from the beginning of the period. Time-weighted returns are designed to measure how well an investor did at increasing their money over a period of time, not the size of the investment or returns.
Dollar-weighted returns. Also called IRR, is the return produced by an investment based on withdrawals and contributions. It can measure size and timing of money invested in a fund over time, as well as the fund performance. When an investor makes more substantial contributions, dollar-weighted returns will be stronger. If an investor makes smaller contributions in the next period, their dollar-weighted returns will be lower, even if the fund performed better. Thus, dollar-weighted returns do not isolate the fund's actual performance
Both methods can be equally useful for assessing investment returns. Investors should use time-weighted returns to see how well they did at growing their assets over time and dollar-weighted returns to measuring the timing of their withdrawals and contributions relative to the performance of the fund.
What is a good rate of return?
Each asset can provide a different rate of return, based on the risk associated with the investment. The ‘safest’ investments still have a possibility of losing some or all of your capital, even investments backed by the government. However, without any risk, there would be no reward.
In 2016, Mckenzie & Company released an analysis of past and future returns on stocks and bonds that provides some great insight on market trends.
The collaboration found that investment returns were at an all-time high between the years of 1985 and 2014, where investors saw real returns (meaning, adjusted for inflation) of 7.9% from stocks, and 5% from bonds. When you add inflation back in, you did well to make 10% and 7% respectively.
These promising returns were due to the decreasing rate of inflation, along with strong GDP growth over the last 30 years. Interest rates also lowered considerably during this period. New markets, low labor costs, and good global supply chains were driving factors of investment returns. However, this trend is expected to slow down considerably.
Though interest rates have some room to drop, it’s more likely that they will begin to increase. Pair that with a slow-growing GDP or inflation and some investment might not be profitable. For example, a CD that promises a return of 1.1% can be worthless when inflation is at 3%.
The Mckenzie analysis predicts that in the next 20 years stocks will provide real returns of 4%-6.5%, with bonds at 0%-2%. When you live in a world that has 3% inflation, you should expect returns of 9.5% and 5%, respectively.
With that in mind, those starting to save for retirement will have to compensate for lower returns one way or another. Younger workers will likely have to increase their rate of saving and may need to retire some years later than expected.
Using the calculator
The calculator is very easy to use. You’ll need to add some details about your investment to get an idea of your returns. Let’s review the questionnaire together
Step 1. On the first line of the calculator, add the number of years you intend to hold your investment. You can use your keyboard or the arrow keys to make this input easier
Step 2. On line two, include the rate of return or your investment, followed by how much you’d like to invest
Step 3. If you want to make additional contributions to the fund, include the dollar amount of your yearly deposits on line four of the calculator
Step 4. Next, add the rate of inflation along with your tax bracket
Step 5. If you’d like to increase your deposits to offset inflation, mark off the selection on the last line of the calculator
Step 6. Proceed to your results.
To the right of the inputs, you can view a smart summary of your investment returns. Compound interest is the earnings generated by your earnings, while simple interest is the earnings from your initial investment. When you combine the two, you’ll get your total investment returns, as indicated below the questionnaire.
You can view the balance by year bar graph, or the summary table for more details. From your results, you can determine if a particular fund is suitable towards reaching your investment goals.