Required Rate of Return (RRR)
Candlefocus EditorThe determination of an investors RRR is an important part of the decision-making process in buying a security. The investor needs to consider many different things when considering the RRR: the cost of capital, the return available from other competing investments, the risk associated with each security, the potential for capital appreciation given the current market conditions, and inflation.
The cost of capital is the amount of money an investor needs to pay for borrowing funds. When calculating the RRR, the cost of capital should be considered. A professional investor may have other sources of capital, such as long term bonds or equity, making their cost of capital lower than someone who is investing their own funds.
In addition to the cost of capital, the RRR should also reflect the return available from other competing investments. An investor must determine which investment will provide the highest boundless rate of return given their personal risk tolerance and other factors. This must also include the effect of inflation on the expected rate of return.
The individual investor also needs to consider their risk tolerance when calculating the RRR. Retirees will likely have a lower risk tolerance and therefore accept a lower return than younger investors with a greater appetite for risk. As such, it is important for investors to assess their personal risk tolerance and utilize a realistic RRR that reflects that.
Overall, the required rate of return is an important factor for investors to consider when assessing a potential investment. It is based on the individual investor's goals, risk tolerance and other factors, and must be adjusted to reflect cost of capital, return available from other investments and inflation. Utilizing this calculation, investors can assess potential investments more accurately and determine whether it is a good fit for their personal portfolio.