Investment is an important topic when managing personal finances. A good investment can generate stable returns and accumulate wealth over time. Recently, I came across an investment opportunity that offers $3850 per year. As an inexperienced investor, I was not sure how to evaluate whether this is a good investment or not. In this article, I will share some key factors to consider when evaluating investment returns, and specifically discuss how to assess if the $3850 annual return offered by this investment is attractive or not.
When evaluating an investment, the first thing to look at is the expected return. This tells you the total gains you can expect from the investment each year. However, return alone is not enough. We also need to account for risk. An investment with high returns but high risk may not necessarily be better than something more stable with lower but guaranteed returns. Therefore, we need to consider the risk-return trade-off. Common metrics used by investors to evaluate this trade-off include the Sharpe ratio, Treynor ratio and information ratio.
Another key factor is the investment time horizon. Is this a short-term investment you need to cash out after 1-2 years, or a long-term investment that you are happy to keep for 5-10 years? Long-term investments tend to have higher average returns than short-term ones, so your required return should be different.
Lastly, we need to compare the return of this investment to other alternatives. For example, how does this $3850 per year offered compare to returns from similarly risky stocks and bonds? What about a simple savings account deposit? Making relative comparisons allows us to assess if this investment represents good value or not.
With these factors in mind, let’s now specifically assess the $3850 annual return offered by this investment opportunity.
Evaluate the absolute return level of $3850 per year
The first step is to evaluate whether an annual return of $3850 seems like a reasonable amount in absolute terms.
For most retail investors, an annual return of $3850 would be considered quite good. It translates to about a 7.7% return on an investment principal of $50,000. For comparison, the average annual return in the US stock market (as measured by S&P 500 index) is around 7-8% over the long run.
However, this needs to be assessed against the investment time frame. $3850 may be a great return for a short-term investment held for 1 year, but it would be more modest if held for 10 years or more. Investors typically target higher average returns for long-term investments.
The investment principal amount also matters. A $3850 return on a smaller $10,000 investment would be more impressive at over 38% gains per year. But on a larger $100,000 investment, it works out to only 3.85% yearly gains.
Overall, $3850 in annual returns seems solid in absolute terms for a retail investor. But a lot depends on the underlying investment principal amount, and the time horizon we plan to hold this investment for.
Evaluate the riskiness of this investment
The next step is to evaluate how much risk this investment carries. Higher risk investments need to have higher returns to compensate investors.
Key factors determining risk include:
– Investment type – Is this investment in stocks, bonds, real estate etc. Riskier assets like equities should generate higher returns.
– Diversification – Is this a single asset or a basket of assets? Diversified investments reduce risk through allocation across many assets.
– Liquidity – Can the investment be sold easily if cash is needed? Illiquid assets carry higher risk.
– Time horizon – Longer investment horizons reduce risk through time diversification.
– Financial leverage – Does this investment use debt or other leverage? Leverage increases risk.
Without more details, it is hard to fully assess the risk of this investment. But being able to generate a $3850 (7.7%) return likely means taking on some moderate amount of risk above a default savings account. The investor needs to determine if the risk-return tradeoff is suitable for their goals.
It may be helpful to use formal metrics like Sharpe ratio. Higher Sharpe ratio indicates the investment is generating good returns per unit of risk taken.
Compare returns to other investment alternatives
The final step is to compare the $3850 return versus other investments the individual can make. This relative comparison allows us to determine if this return is truly attractive.
Some key alternatives to compare against include:
– Savings accounts – These offer guaranteed returns with zero risk, currently around 0.5-1% APY. Comparing to this shows the risk premium earned.
– S&P 500 index funds – These carry market level risk and generate 7-8% long run average returns. Comparison shows if $3850 exceeds market returns.
– Aggregate bond funds – These invest in basket of bonds with modest risk. Currently yield around 3-4% annually.
– Real estate funds – These invest in property and have moderate risk. May yield 6-8% on average.
– Peer investments – Other investments of same type and with similar risk.
Based on these comparisons, the $3850 return seems moderately attractive. It exceeds savings accounts, is similar to S&P 500 returns, and beats investment grade bonds. This suggests the investment risk premium and excess yield looks reasonable. However, without more details, it is hard to fully conclude if this return is truly above average or market competitive. The investor needs to make more precise relative comparisons before deciding to invest.
In conclusion, an investment offering annual returns of $3850 seems moderately attractive in absolute terms and relative to alternative options for a retail investor. However, fully evaluating its merit requires assessing the principal amount, time horizon, risk level, and making precise comparisons against alternatives of similar risk. While the return seems decent, more analysis is needed to determine if this investment is truly a good value addition for one’s portfolio.