Failure to Understand Returns

The highest return possible with the lowest tolerable risk best describes the objective of most investors. Investing is really a game of averages and not home runs.

Very few investors actually understand what rates of returns are possible or how dramatic those rates of return will impact their investments.

The power of compounded returns can be astounding. It is best defined by a little known mathematical formula known as the Rule of 72. Simply stated it tells us that any number divided into seventy-two will provide another number, those two numbers tell us how long it takes to double money at any given rate of return.

As an example:

  •  Money doubles in 12 years at 6%.
  • Money doubles in 10 years at 7.2%.
  • Money doubles in 7.2 years at 10%.
  • Money doubles in 6 years at 12%.
  • Money doubles in 5 years at 14.4%.
  • Money doubles in 4 years at 18%.

There is a relationship between risk and rates of return. Higher rates of return involves higher levels of risk. Very much like a blindfolded archer, it helps to know where the target is. If the rates of return you are seeking are not consistent with the level of risk you are willing to tolerate, you may be making a big investment mistake.

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