The Equivalent Rate of Return Defined

Equivalent rate of return is simply how much your investment is growing in a particular financial situation where you know the exact amount of money your investment will yield in the future. In more financial terminology, equivalent rate of return is a financial calculation that helps investors compare investments based on projected future cash flows.

To further define, Equivalent Rate of Return is the rate by which a future flow of cash must be reduced to equal the initial investment hence the term equivalent in addition to rate of return. The reason Equivalent Rate of Return is used instead of simple rate of return is that a standard rate of return does not tell the investor how much money they are making as a percentage in excess of their initial investment.

Equivalent rate of return makes use of two key variables, 1) investment amount and 2) future cash flows. Investors use the equivalent rate of return to make sure they are not overpaying for a future stream of money or investing in the wrong project. The following example illustrates equivalent rate of return further.
Example 1: If your income from an investment is $1,100 per year for 20 years,and your initial investment was $10,000, how much would the annual returns have to be reduced so their total adds up to the same amount as the initial investment. The answer would be your equivalent rate of return.

For additional clarification, the equivalent rate of return is also termed Internal Rate of Return as per definition. (moneychimp.com) That is to say, both Equivalent Rate of Return and Internal Rate of Return calculate the same thing and are considered interchangeable for this particular use of the term.

How to calculate equivalent rate of return

Calculating equivalent rate of return is a matter of entering the future cash flow variables in to 1) a manual equation, 2) a calculator or 3) online or built in software application. The simplest and fastest method is to a let a computer program do it for you. This not only saves time, but also the effort of having to figure out which sequence of small buttons to press on a financial calculator or writing down and calculating present value and rate of return equations on paper. That said, the three methods are described below:

• Method 1: Online Equivalent Rate of Return Software

For this method of calculating Equivalent Rate of Return, simply plug in the future cash flow numbers into the 'input cash flow' boxes at the following link. Remember to use a negative sign before the first number as this is how much money you are investing and is cash flow out not in. The discount rate in the following IRR calculator is somewhat ambiguous as this is better termed an expense rate reduction. The discount is also used to refer to IRR as the return is 'discounted' by the IRR. However, this is not the case in this particular application. Microsoft Excel also has an Internal Rate of Return aka Equivalent Rate of Return calculation function.

http://www.datadynamica.com/IRR.asp

• Method 2: Financial calculator

Depending on which calculator you use the exact method may differ. However, financial calculators have specific IRR function that allows you to calculate equivalent rate of return. One example being the Texas Instruments BA II Plus which makes use of its Cash Flow (CF), Net Present Value (NPV), Internal Rate of Return (IRR) and Compute buttons. Essentially, the same process as in the software method above is used except instead of entering the cash inflows and outflows in the boxes they are done using the CF button, NPV, Interest (I) and then pressing Internal Rate of Return (IRR) then Compute (CPT). These instructions are illustrated in full at the following link.

http://www.fiu.edu/~barberj/calculator.htm

• Method 3: Manual method

Calculating equivalent rate of return manually involves 1) averaging the rate of return on investment of a future series of cash flow, and 2) determining how much that rate of return must be reduced when applied to the cash flows in order for those cash flows to equal the initial investment. The following is a trial and error approach to determining equivalent rate of return. This and other manual calculation methods can be found in the subsequent links.

Step 1: Add up total cash flows and divide by total initial investment
Step 2: Choose a percentage by which the rate of return can be reduced to yield an estimated amount similar to initial investment
Step 3: Adjust discount rate until final net value of cash flows equal initial investment.

http://hadm.sph.sc.edu/Courses/ECON/invest/invest.html
http://invest-faq.com/cbc/analy-int-rate-return.html

In summary, Equivalent rate of return is the rate by which a net amount of money you would receive in a series of future cash flows must be deducted or 'discounted' from the total actual average return on investment. Equivalent Rate of Return can also be calculated as a non-average value if cash flow is consistent. For one additional example, assuming it doesn't matter when you receive a cash award, which would you rather have $1000 now, or $500 with an annual rate of return of 10% over 10 years non-compounded? The answer is it doesn't matter because the rate of return of 10% is equal to the value of the $1000 over 10 years not including inflation risk.

Sources:

1. http://www.moneychimp.com/articles/finworks/fmpresval.htm
2. http://hubpages.com/hub/Internal-Rate-of-Return-for-Dummies
3. http://moneyterms.co.uk/irr/

How to Figure Out The Total Return of a Mutual Fund

Calculating the total return of a mutual fund involves 1) defining the variables within the calculation, 2) using the right formula for the calculation and 3) inputting the correct variable numbers into the calculation. Mutual funds are managed portfolios of multiple investments from multiple investors, and are subject to Federal regulations. Since each mutual fund may have a different fee, worth and payment structure, calculating the total return for each Mutual fund may be different. Some of the key variables in calculating total return of mutual funds are the following:

• Expense ratio of mutual fund
• Original investment amount
• Time period of return
• Net Asset Value (NAV)
• Dividend payments if any

Nuances of total return

In the world of investment returns there is specific lingo that sometimes applies to the calculation of returns. Terms are used to describe the nature and type of return; for example 1) annualized return 2) real rate of return and 3) compounded return are all important concepts in the accurate calculation of total return. Some terms sound similar, but mean different things such as yield and return. Understanding the meaning of the variable input is useful in making sense of the total return calculation.

For mutual fund calculations, the Net Asset Value (NAV) is important because it changes over time, thus a beginning and end NAV are required. In addition to NAV, dividends, expenses, compounding and inflation may or may not be factored into the total return equation. Once all the proper terms have been sifted and sorted, the next step is to use a formula in calculating the total return.

How to calculate the total return of a mutual fund

Calculating the total return of can be performed between partial and complete accuracy, meaning there are different formulas for calculating total return depending on how complex and accurate the variables and the formula they are used in are. For example, the methods below, as sourced from stock-market-investors.com, illustrate two simple methods of calculating total return followed by more elaborate equations that include additional variables. Since some investment accounts also accrue interest, an additional variable of compounded interest may be used with adjustments in the time value of money using an inflation variable. For some return calculations, specifically the simpler ones, online financial calculators may be of use.

• Formula 1: Total return without dividend payments:

(NAV2-NAV1)/NAV1-1= Total return without dividends

• Formula 2: Total return with dividend payments, and no expense or inflation deductions

[(NAV2-NAV1)+D]/NAV1=Total return with dividends

NAV2=Investment value at end point
NAV 1=Investment value at start point
D=Dividend(s)

• Formula 3: Total return with monthly compounding and cost basis:

Variable 1: CB=(NAV1-front end expenses)-(NAV2+back end expenses + fees)
Variable 2: Annual Compound Rate(ACR)=Formula 2 divided by NAV1+CB
Variable 3: ACR exponent= 1 divided by years held

Cost basis and annual compound adjustment formula:

ACR to the power of (multiplied by) ACR compound exponent adjustment (as above in variable 3) minus 1

• Formula 4: Total return with monthly compounding and cost basis

To adjust the compounding to be calculated monthly divide the ACR exponent i.e. annualized percentage rate value by the number of months.

ACR divided by 12 multiplied by number of months, to the power of ACR annual compound exponent adjustment which is equal to numerator 1 divided by 1/12 times number of months, minus 1

• Formula 5: Including inflation as a variable

Since inflation reduces the value of money, the annual inflation rate can be subtracted from the total return to obtain the real total return of the mutual fund. For monthly inflation deductions the inflation rate that is subtracted is divided by the number of months used in the ACR.

Ex: Formula 3 - Inflation rate
Ex2: Formula 4- Inflation rate / number of months

Summary 

Total return on Mutual funds varies on how the return is calculated, and the variables and numbers used. This article has illustrated terminology and formulas used in the calculation of total return for mutual funds. Sometimes calculators may be helpful in arriving at a final value however, understanding the quantitative terminology in Mutual Fund total return calculations is helpful in properly utilizing the correct equation. Depending on which formula is used, the cost basis adjustment, compounding and inflation if any, the total return may differ from that quoted by the Mutual fund itself.

Sources:

1. http://www.globefund.com/centre/GettingStarted06.html
2. http://www.stock-market-investors.com/pick-a-stock-guides/calculate-return-on-investment.html
3. http://www.procalcs.com/

Wealth Accumulation: How to Save a Million Dollars

Millions of people have already saved a million or more dollars. According to the website of U.S. Senator's Bernie Sanders of Vermont, in 2009 7.8 million people were millionaires in the United States despite the economic environment. The characteristics of these people have, that would be millionaires don't have add clues to how to save a million dollars. If it were easy to save a million dollars, many more would have already done it, but how to save a million is not really a secret at all.

• Return on Investment (ROI)

Money is a resource like oil, labor and time. When money sits idly by doing nothing or isn't optimized for efficiency that resource incurs opportunity costs, becomes subject to inflationary pressure and lowers potential income. Making proper use of money such as through astute business and financial decision making can lead to returns on investment well into the double or even triple digits.

• Compounding, and Capital gains

Financial principles are the concepts behind economic thinking and day to day finance. Understanding principles like leveraged hedging, business cycle, capital appreciation, and compounding are stepping stones to implementing them in one's financial plan. Financial plans don't have to be complicated, and simple often is better, but either way a financial plan that correctly employs financial methods that work is essential to save a million dollars.

• Assets minus liabilities

Net worth is a financial concept that claims what goes out should be less than what comes in. If at any level this is not the case, saving a million dollars will likely not be possible in any conventional sense. The formula for net worth is easy to understand but hard to do, but is a way to save a million dollars.

• Vocational decisions

According to the U.S. Bureau of Labor Statistics, surgeons, engineers, scientists, lawyers and pilots all receive over $100K per year. Saving 50 percent of this amount every year without any ROI or compounding will save a million dollars after 20 years. Some millionaires may work hard toward their goal and simply earned their way to wealth through a high paying job or lucrative business.

• Financial instruments

A wide variety of financial instruments and methods exist to become wealth. When used correctly becoming a millionaire is only a matter of time, skill and know how. From annuities to zaitech, a wide range of investment and asset allocation methods exist that have made many millionaires. Keep in mind some financial instruments do involve considerable risk.

• Tax protection

Paying unnecessary taxes is a way to slow down wealth accumulation. To save a million dollars tax strategy can come in handy, and a number of legal tax shelters and financial techniques exist to reduce taxes thereby decreasing money paid out. For example, deferring unneeded income to future dates lowers taxes in the present.

• Use a financial plan

Sticking to a financial plan provides a good way to save a million dollars. For example, $999 USD that is added to by $99 per month for 60 years at 7% is equal to $1,031,070.37 with compounding once a year. If this interest accumulates and is contributed to within a traditional retirement account, tax will not have to be paid on it until withdrawal. Naturally, acquiring a high interest rate in as short a time period as possible is the challenge when using a savings method like this.

Knowing how to save a million dollars isn't necessarily difficult, implementing the steps that allow one to save a million dollars does require financial discipline, skill and usually effort. Limitations on people's income, high cost of living, financial obligations and unforeseen expenses can all drill holes into an otherwise solid financial plan. Overcoming these obstacles by utilizing one or more of the above steps will increase one's probability of saving a million dollars.

Sources:

1) http://bit.ly/daFpxy (Vermont Senator)
2) http://bit.ly/dWWXh (MoneyChimp)
3) http://bit.ly/cP6bBX (Bureau of Labor Statistics)

Calculating Your Return on Real Estate Investments

Calculating return on real estate investments at its most fundamental level involves subtracting all the costs paid into a property from both revenue earned during the term of ownership in addition to selling price. Subtracting the buying price from the selling price is simply not an accurate way to determine real estate return because there are so many underlying benefits and costs associated with property ownership that occur on an annual basis.

In other words, real estate investing is complicated by the myriad of revenue and cost sources incurred over the term of ownership. Furthermore, in the case of real estate investment groups, and property managers, calculating return on investment is more of an annual than end game operation making profitability, and debt calculations in the form of percentages and ratios rather than simple positive or negative numerical amounts quite relevant in the assessment of return on investment.

To simplify the return on investment a good approach can involve staying organized throughout the whole investment process from start to finish while simultaneously utilizing the numerous techniques and tools involved in assessing return on investment. This means keeping track of and recording every dollar and cent put into the property and every dollar and cent returned in the form of capital gains, and tax benefits. The following sections break down the property investment process into the fundamental units of revenue, cost and techniques that can assist in the calculation and assessment of return involving the revenue and costs from the sections below.

Sources of property revenue and expense

The sources of property revenue tend to less than the numerous costs and expenses that a property can incur. For this reason it is quite vital to maximize and optimize the potential revenue of a real estate investment in order to make it worthwhile. Two lists comprised of both the source of property revenue and expense are listed as follows:

1. Source of Property Revenue:

• Capital gains (after deduction of overhead if applicable): "Profit" on the sale of the property as calculated in terms of purchase price.
• Rental income: Income earned through lease, rental or use of space by a third party.
• Tax deductions: Tax savings such as mortgage interest,
• Tax Credits: Additional tax savings such as renovation credits

2. Sources of property expense:

• Original settlement costs of real estate: All costs associated with purchase of property
• All maintenance and renovation expenses: Upkeep, repair and remodeling.
• Operating expenses/Overhead (if not deducted from capital gains): Utilities
• Total ammortized interest payments at time of sale: The sum of total interest payments
• Tax on Capital gains: Government tax incurred from profit on the sale of property
• Hazard Insurance: Protects against losses from unforeseen events
• Mortgage Insurance: Premium paid as a protection feature should the real estate enter default or foreclosure. (this expense can be avoided in some cases)
• Government Recapture tax (If applicable): Tax associated with sale of property financed by Government sources.
• Back end expenses associated with sale of property: All costs associated with sale of a property.
•Opportunity cost (if applicable): The potential loss of profit due to fixed nature of property investment i.e. loss of revenue from missing a more profitable investment
• Inflation: The cost of inflation is also an expense as this can amount to approximately 2-3% of the total value of a property per year.

As evident from the above list, there can be many more sources of expense than profit from a property investment which hints at the necessity for fiscal prudence and keen judgment when purchasing property. When purchasing a property it may be helpful to forecast and estimate the total costs of the property purchase and estimated market value of the property at a future time to assess whether or not the investment will be profitable. It can be easy to overlook some of the many expenses and costs that go to into a property making the purchase and sale prices of property somewhat inaccurate measures of the profitability of the real estate.

In essence, calculating the return on real estate investments is a numerical balancing act combined with market forces, and investment savvy. Knowing the dynamics of the real estate market, trends, property factors such as upkeep, maintenance and renovation expenses etc. are all important to turning a profit in addition to optimizing as many of the possible benefits of property as possible. The benefits of property ownership include all sources of savings, expense reduction, income and capital gain that can be squeezed out of a property.

Tips and techniques to consider in calculating return on real estate investment

One of the most opportune times to calculate the return on real estate is before it actually happens in the form of a property profile. In other words, assessing all the potential advantages and disadvantages before the property is even purchased can not only help in future calculation of return on investment, but also the front end costs. The tips below can help with the calculation of and the forecasting of return on real estate investment.

• Develop a bookkeeping system
• Utilize Investment return equations in forecasting return
• Investigate all tax implications, costs, and benefits
• Assess market conditions and real estate potential
• Optimize property income
• Reduce costs

Return On Investment Equations and Software

When forecasting and calculating annual rather than total end profits on real estate, numerical equations and software tools can be used to calculate return on investment. These tools can be especially useful amidst business property investments within fluctuating market conditions. In other words these tools help organize the many variables of property management into orderly numerical functions that provide quick and accurate answers provided the input numbers are correct. A few examples of such equations are listed below:

• Debt Coverage Ratio: Operating Income/Mortgage costs (associatedcontent, Butler)
This equation measures annual income as a percentage of cost. A division ratio that assesses profitability in terms of a ratio result rather than percentage amount. Also useful in assessing debt.

• Capitalization Rate Valuation: Net income before mortgage expenses including operating expenses/Capitalization Rate i.e. annual percentage rate of return(ezine.com, S.Gillman) Helps assess overall property value in terms of annual income before mortgages expenses are deducted.

• Total Yield: Annual Income/Sales Price (associatedcontent.com, Butler)
Measures annual income as a percentage of sales price and therefore does not include expenses and costs.

• Cash on Cash Return: Annual Income after mortgage costs/ Downpayment (associatedcontent.com, Butler) Provides an annual estimate return on initial investment after costs and is good for assessing real estate investment risk and opportunity cost.

There are also several software packages and online tools that can be utilized to calculate annual returns on real estate investment. It can be a good idea to have a strong understanding of the big picture when utilizing such tools because the tools themselves only measure isolated circumstances of revenue and cost variables.

In other words, in order to acquire an accurate assessment of return one must 1) enter the correct input variables and 2) correctly sum and utilize the outcome of all applicable equations. That is to say estimated income and credibility of the equations should be sound. The more such equations are used, the more complete the overall return on investment assessment is likely to be. An example of a free online real estate return calculator can be found at the following link.

http://www.frontdoor.com/tools/calculators/return_on_investment.aspx

To summarize the above, calculating return on real estate revenue is essentially a simple task. However, this simple task is complicated by the multiple and ongoing costs and sources of cost reduction associated with the ownership of a property. For this reason, sound bookkeeping and awareness of all the variables can be of great benefit to accurately assessing the real return on a property.

The many costs and expenses of property are sometimes overlooked when making the investment return calculation in addition to overlooking the potential reductions to capital gains such as maintenance costs and environmentally friendly renovations that may incur a significant tax credit translatable into gain from ownership of property before the property is even sold.

Sources:

1. http://athenianloans.com/Tax_Effects.html
2. http://www.HousesUnderFiftyThousand.com/due-diligence-checklist.html
3. http://ezinearticles.com/?Say-Goodbye-To-The-Gross-Rent-Multiplier&id=303508
4. http://www.associatedcontent.com/article/27644/calculate_the_return_on_your_real_estate.html?page=3
5. http://www.community-newspapers.com/archives/lgwt/20060222/lgperkins.shtml