If you noticed something important in the title, it was the fact that I put the word REAL in there. We all know returns are important - obviously the more you can generate in a year the better. But what are REAL returns? Real returns in the most simplest definition is the returns that you get that are adjusted for inflation. Why is it important to include inflation in your returns? Inflation is the persistent rise in prices. Every year, generally prices tend to go up - usually by 1-2% annually. In Canada, this is measured by the consumer price index that tracks a basket of common household items like bread, basic clothing, cars, gas etc. Some products go up in price faster than others but overall the basket raises by 1-2% annually.
The reason why inflation is important is because it decreases your purchasing power over time. Every year that prices go up, your money buys you less of a certain product. In Canada, with an inflation rate of 1.64% last year, each dollar you have can purchase 1.64% less of what you bought in the year previous.
From a financial standpoint, this means that when you invest your money you need to be at least matching the inflation rate so you do not lose your purchasing power. This is why many people argue against just leaving your money in the bank or at a low value GIC. A typical cash account in Canada yields 0.5%-0.75% with GIC’s yielding 1-2% depending on the term (2% is 5year term). If you leave your money in the cash account your purchasing power decreases by about 1%. With the long 5yr GIC you only net 0.3% on average a year contingent on the fact that inflation stays constant through your term.
What is the ideal return then?
At the very least, regardless of the product that you are using make sure you beat the inflation rate. After that factor in your fees if you use a fee based product. From here, you must add the % that you desire your money to actually grow by.
How do I calculate my returns?
Its great when you hear people talk about returns. Some people make 8%, some 5% and in cases like 2016 where 12% was common. Keep in mind all these returns are the nominal return. Nominal returns are the percentage return that have not been adjusted for inflation.
Calculating your return in quite simple
Final Value at year - Initial Value
------------------------------------------ * 100 = Nominal Return - Inflation Rate = Real Return
The above formula will give you an approximate indication for your return. If you have any questions about returns or on how to read statements to find your returns let me know in the comments.
Disclaimer: All of the above information is my own personal opinion. Figures above are for learning purposes only. Formula for real return is an approximate formula. Please consult with a licensed representative and do your research before making any financial decision.
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