The highest return possible with the lowest tolerable risk best describes the objective of most investors.
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 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%.
History tells us that various kinds of investments have provided the following rates of returns over the past seventy years.
Treasury bills – 5%.
Government bonds. – 7%.
S & P 500 Index of large capitalization common stocks – 10%.
The Wiltshire 5,000 Index of small capitalization common stocks – 12%.
(Past performance does not guarantee future results.)
Many people have identified their expected rate of return as:
- Equal to the historical rate of return from highly speculative investments.
- Equal to the historical rate of return from small capitalization common stocks.
- Equal to the historical rate of return from large capitalization common stocks.
- Equal to the rate of inflation plus 2%, or approximately that of government bonds.
- Equal to the rate of inflation, or approximately that of treasury bills.