Rate of Return
Candlefocus EditorThe rate of return can be used to analyze and compare various investments, such as stocks, bonds, real estate or art, but not all investments are created equal. For example, stocks can have higher returns than bonds, but also pose a higher risk. Real estate investments can provide steady returns, but also involve long holding periods, while art investments can have wildly varying returns depending on artistic trends.
The most commonly used rate of return calculation does not take into account the effects of inflation. The cost of items bought today, such as food and clothing, will be more expensive in the future. This means the rate of return for certain investments may be reduced when taking inflation into account. Fortunately, investors can use the real rate of return calculation to adjust for inflation.
The internal rate of return (IRR) is also useful for measuring investment success over time. Unlike the simple rate of return, the IRR calculation takes into consideration the time value of money. This means that an investor would expect rewards for taking larger risks with their investments. If a person invests $500 in stock, the immediate rate of return may be 40%, but when taking the time it takes to receive the return into account, the rate of return could be much lower.
The rate of return can provide a basis for comparing investments of different values over time, but investors should keep in mind that a high rate of return may lead to higher risks. Additionally, when making long-term investments, it is important to calculate the real rate of return to take inflation into account or use the IRR calculation to adjust for the time value of money. However, in all cases, regardless of the investment, the true rate of return will be heavily dependent on the market conditions present at the time the investment was made.