Rate of Return – it is risk adjusted rate of return that matters

October 10, 2018 | Posted by: Calum Ross

When you’re investing, rate of return is a key metric you want to pay attention to. Simply put, it’s the gain or loss of your initial investment over a specific period of time. For example, if you invested $100 today and your investment grew to $105 a year later, then your rate of return would be 5%. Pretty simple, right? While rate of return is important, it’s the risk adjusted rate of return that matters most.

You can invest your money in many things – stocks, bonds, ETFs, mutual funds, real estate and the list goes on. A common argument is whether it’s better to invest your money into real estate or buy investments. Let’s examine the investing option first.

Investing in the Canadian and U.S. Stock Markets

Let’s say you invested $100K in the Canadian and U.S. stock markets over the last 10 years. Where would you be today?

If you had invested $100K in the TSX, with a 4.70% average annual rate of return over the last decade, you’d have $158,295 today. Not bad.

What about the Dow Jones Industrial Average (DJIA)? If you had invested $100K in the DJIA, with a 11.29% average annual rate of return over the last decade, you’d have $291,448 today. Even better.

So, that’s the investing option. Let’s look at the real estate market next.

Investing in the Toronto Real Estate Market – Leveraged vs. Unleveraged

How about instead of investing in the stock market, you invested in the Toronto real estate market over the same time period. Where would you be today? Over the same 10 years the Toronto real estate market had an average rate of return of 7.80%. That’s better than the TSX, but not as good as the DJIA.

Similar to the investing examples earlier, to do a fair comparison, let’s assume you have the same $100K to invest. Now, obviously, you can’t buy a property in Toronto for only $100K, but let’s say you bought a condo with your parents 10 years ago as equal owners. What would your investment be worth today? Your initial investment of $100K in Toronto real estate would be worth $211,928 today. Pretty good.

Now, that’s unleveraged, using your own money. What if you borrowed the bank’s money by way of a mortgage (leveraged) and invested in the Toronto real estate market? Where would you be today?

If you had invested $100K and purchased a 500K property in Toronto (that’s an 80% loan-to-value for those math whizzes out there), your 500K property would be worth $1,059,638 today. Assuming you paid down your mortgage over the last 10 years, that’s a 959.64% rate of return. Amazing! That blows all of the other options out of the water.

How did we accomplish this? Through the power of leverage. Leverage is using other people’s money. In this example, it was the bank’s. It’s how the wealthy get even richer.

Using Leverage Strategically

Just a word of caution. While leverage can magnify your gains, it can also magnify your losses. While real estate generally goes up in value long-term, there’s no guarantee. The same can be said for the stock market. If you instead borrowed money to invest and cashed out at the wrong time (such as the financial crisis), your losses would be amplified.

This isn’t to scare you away from leverage. It’s to tell you both sides of the story. Leverage is a powerful tool when used strategically. To minimize your risk, it’s best to use a leveraged investment strategy long-term. That way you don’t need to be concerned about the daily fluctuations in your investments. Real estate is generally a safer investment than the stock market. it’s the risk adjusted rate of return that matters.

Anyone who understands real estate economics and capital markets knows that what goes up must come down. Anyone who thinks Toronto real estate is set to do anything other than under-perform and/or (GASP) go down considerably simply has delusions of grandeur. The time is now to get a great investment advisor, deleverage and cash in your speculation chips before the game is over and you are the loser.

Pre-construct condo ‘investors’ and syndicate mortgage ‘investors’ are set to be the biggest losers as they are very likely already too late to cash in their chips. If you want to know what to do now – we are once again open to the public.

No mortgage or financial planning team in this country does more borrowing to invest or borrowing for wealth creation than our team. We have the business track record and formal education to support your plan and to help you achieve your financial goals. Volatile markets create opportunities and we would love the opportunity to help you capitalize. Call our office today to discuss how we can help at 1-855-410-9905 or email ClientCare@CalumRoss.com 


Sources:

DJIA: http://quicktake.morningstar.com/index/IndexCharts.aspx?Country=USA&Symbol=$INDU

TSX: https://www.taxtips.ca/stocksandbonds/investmentreturns.htm

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