## Understand Financial Returns

### Basic Rules

• Compare apple to apple - compare investment return with same products or criteria.
• Time has the value - start investing early.
• Understand that compounding - the earning of interest on reinvested interest - can increase investment return dramatically.
• Understand compounding frequency - the more often you get paid for interest, the faster your money will multiply.

### Where is the return comes from?

• Return from interest - savings, GIC, bonds etc.
• Return from captial gain - stocks, mutual funds
• Return from Dividends - stocks (Over the past 50 years, dividend return is around 4%, account for 40% of index’s return)
Interest raturn chart
Stock return chart
Index total return around 11% long run

### Types of Returns

• Arithmetic return: Average the sum of returns by number of periods.
• Geometric return: Multiply all returns(1+r) for n periods, and then take the nth root.

### APR and EAR

• APR (Annual Percentage Rate): APR is the conventional method of quoting interest rates that completely ignores the compounding effect. It is widely used to quote for products such as consumer loans, residential mortgages, and bond yields.

APR = n(number of periods) * R (rate of return per period)

For example, an investor is quoted "The interest rate shall be 12% per annum, compounded and payable monthly." The quoted rate is APR at 12% (12*1%), or 1% per month. However, this 1% interest paid out could have earned interest for the investor for another 11 month, if the investor doesn't have to pay it out right now. The actual annual interest rate paid by the investor should be higher than the 12% quoted by the financial institution.

• EAR ( Effective Annual Rate): It is the rate investors actually realized as a result of compounding. EAR increases as compounding frequency increases.

Back to the example above, the EAR should be 12.68%, calculated as .

### Dividend Yield

A financial ratio that shows how much a company pays out in dividends each year relative to its share price. In the absence of any capital gains, the dividend yield is the return on investment for a stock. Dividend yield is calculated as follows:

Dividend yield is a way to measure how much cash flow you are getting for each dollar invested in an equity position - in other words, how much "bang for your buck" you are getting from dividends. Investors who require a minimum stream of cash flow from their investment portfolio can secure this cash flow by investing in stocks paying relatively high, stable, dividend yields.

### Rule of 72

How long will it take you to Double your investment? --- Dividend 72 by your rate of return.

For example, If you earn 10% a year on a \$5,000 investment, it will take 7.2 years (72/10) for your investment to become \$10,000.

### Rule of 113

How long will it take you to Triple your investment? --- Dividend 113 by your rate of return.

For example, If you earn 9% a year on a \$5,000 investment, it will take 12.55 years (113/9) for your investment to become \$15,000.