Investing In Managed Funds and ETFs – The Rate of Return

In my previous post we introduced the idea of investing in managed funds and ETFs. It was suggested that before we start any investment journey and process that we need to be familiar with the rate of return.

We invest after all to make a profit or gain but we need to understand how realistic this profit or gain that we want or pursue really is.

Firstly, a definition. What is the rate of return? In simple terms it is the performance of our asset over the period we are measuring, expressed in percentage terms.

Let’s say we wish to measure one of our investments over the past 12 months. Usually, there is two components to the rate of return:

1.The income component, which is the dividends or interest we receive,

2.The appreciation of the investment in price, i.e. the current price over the initial price.

We can put this information into a formula to help us calculate the rate of return. The formula is expressed as follows:

Income per share + (current price per share – initial price per share) / initial price per share x 100.

The above is a mouthful so let’s look at an example. Assume the following:

We purchased an investment for $1 per share,

We received 0.05 cents per share as a dividend,

At the end of 12 months our investment has climbed to $1.10 per shares.

What’s our rate of return? According to our formula we have the following:

0.05 + (1.10 – 1.00)/1.00 giving us 0.15/1 x 100 or 15%.

If you have lightening mathematical skills, you may have identified that the income of 0.05 cents per share equates to 5% and the increase in price equates to 10%. Adding the two together gives you the 15% return.

Understanding the rate of return is an important first step. I often work with people who come to see me wondering if they will be financially ok in their retirement. An impending retirement comes with many mixed feelings including the thought of running out of savings.

Many of the people I see have reasonable superannuation balances but are still unsure of what it means for their retirement. However, understanding the rate of return goes some way to allaying fears.

We can illustrate this as follows. Assume someone with a superannuation fund and a balance of $1.5 million averaging 8% a year. Generating 8% a year on average on $1.5 million means your balance is growing by $120,000.

As you approach retirement you can assess if this amount will suit your retirement. If you spend $120,000 a year in retirement you are effectively spending the return you achieved for the year. This means your fund will maintain its $1.5 million balance. If you wish to spend more that $120,000 a year, your superannuation balance will then start reducing. But it could still reduce slowly depending on how much more you take out. This means that your retirement funds can still last the journey. If you spend less than $120,000, your superannuation balance actually starts growing.

The rate of return therefore can give you a basis for you understanding the impact on your superannuation savings and how long these funds can potentially last.

With that said, what kind of rate of return can we expect and what are some of the rates of returns for various investments.

I’ll finish this post by having a brief look at some of the more popular investments here in Australia starting with some of the industry superannuation funds. We often see advertisements that these funds are returning anywhere between 8%-10% a year on average for their balance funds.

Balanced funds will have approximately 75% to 80% of funds in growth assets such as shares and the remaining in conservative assets such as government bonds and cash.

Below are some average annual returns for various periods to 30/06/2024.

The above table is to give you an idea and set the scene for future posts. The two Vanguard funds mentioned above are so called index funds which I will cover in future posts. Index funds give you exposure to the market by replicating an index such as the ASX200 being the top 200 shares in Australian. Active funds on the other hand try to beat the performance of an index. How they fare is a discussion for future posts.

It is enough for the moment to understand that using Vanguard funds as a proxy for Australian shares, we expect to earn a little over 8% a year on Australian shares.

Same with the international fund. If we decided to have some exposure to an index of global shares, we should expect our rate of return to be a little over 13% a year on average. We can therefore see global shares have outperformed Australian shares over the past 10 years on average.

Galanis Financial Group can provide tailored solutions to suit your individual circumstances. For further financial advice on ETFs and Managed Funds, contact Galanis Financial Group.