Monday, August 20, 2012

The Folly of Chasing Returns (Part 1)

The Folly of Chasing Returns (Part 1)
Undoubtedly, our overarching reason and motivation for investing our money is to grow it. This is why the return/interest we might receive is one of the first things we consider when reviewing possible investment choices – and rightly so. However, many American investors have been fooled by comparing returns in a vacuum, so to speak.

Let me use this story to illustrate: An investor is comparing two options. Choice A quotes 5.5 percent interest while Choice B’s quote is 7.5 percent. To many, this may seem like a foregone conclusion, an easy choice. But when it comes to returns on money, you should never, ever forget the old saying: The devil is in the details.
In my opinion, there are three very important questions you should be asking when you see prospective investment returns. First would be:
Are these returns quoted before or after any fees associated with this investment?
I’m sure that even the world’s most novice investor would not expect his/her money to grow by any fees associated with his/her returns. Therefore, all fees must be discounted from any returns associated with your portfolio.
Now, let’s continue with our example. Choice A’s 5.5 return was after fees had been subtracted. However, Choice B’s 7.5 percent is the gross return, before it’s 2.5 percent fee. So 7.5 minus 2.5 equals 5 percent. Aha! Being the math genius you are, you can now see that Choice A is better than B, all other things being equal.
Keep in mind, whenever you see those interest rates being quoted left and right, you must make sure that you level the playing field before you make any comparisons or choose favorites. As it turns out, things aren’t always as they may seem.
I said there are three important questions, but so far have mentioned only one. Check back for part 2 in my next column.
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