Thinking Rationally About Investment Returns

One of the most common reasons why people fall for investment scams is because of the very high returns promised for a very short period of time.

The inspiration of this post is to hopefully give investors out there a quick mental framework on how to think rationally about investment returns and hopefully make them a little better in identifying investments that are plausible vs hoax.

Case in point is one of the Philippine's biggest investment scam w/c reportedly promises 62% return in just 20 days or equivalent to 1,131.5% per year according to PinoyMoneyTalk.com.

Now quoted at 62% for 20 days it might mentally deceive ones brain to accept the very attractive offer. But when you do the math, the numbers will really look funny and on first glance would look nothing but - for lack of a better word, a joke.

Here's why.

Let's assume you were offered that deal 27 years ago and say you had P10,000 back then. How much money would you have now at 1,131.5% return every year? Note that the reason why I have chosen 27 years is because we will compare it later with LEGIT investments that had recorded data going back 27 years.

The answer is:

 

You will end up with 5.9 Nonillion Dollars vs a World GDP of only 75.6 Trillion Dollars. That means even if you add up ALL the money in the world it would still not be enough by a HUGE MARGIN for you to get your money back at their supposedly "promised" rates of return. Therefore as a rational investor, you can conclude that the investment is too good to be real.

Sure, it could work for a little while but it is definitely not sustainable in the long term. As a rational intelligent investor you don't want to put your investments where in "Hey it's working great this month! but it may all be gone next month, or the next next month, or the month after that" - you get the point.

Now one would ask, "Ok, so if a return of 1,131.5% per year is too good to be plausible, what return is plausible?"

Now this question is a good one but is harder to answer since investment returns is a function of the size of your capital. Meaning it's easier to grow P10,000 to P20,000 than to grow P10Billion to P20Billion.

What we can do is observe how the market benchmarks have done in the past and I'm also adding one of the best investment records in history from Warren Buffet's Berkshire Hathaway Inc. Let's look at the numbers.

Annual Returns: Warren Buffet (BRK/A) vs PSEi vs S&P 500 (27 Year Period), Currency Agnostic

Equity Curve: Warren Buffet (BRK/A) vs PSEi vs S&P 500 (27 Year Period), Currency Agnostic

Now even Warren Buffet - arguably the best investor in the world who became the richest person in the world solely from investing has a Compounded Annual Growth Rate (CAGR) of 17.43% for 27 years while the PSEi and and S&P 500 has 8.41% and 8.17% respectively. Therefore, if you're an average investor, expecting around 8% return on average would be rational. And, if you're as good as Warren Buffet getting about 17% on average is pretty realistic, sure some investors can still go to 20%, 30% or even 50%+ occasionally during very good times but no where near the guaranteed 1131.5% per year from those investment scams.

Happy investing.

DISCLAIMER: 

This is not an investment advice and the author shall not be responsible or liable for any trading or investment decisions made based on this information.

The author hereby expressly disclaims any responsibility for any error or inaccuracy in the information.