Factors Affecting Investment Return

As you decide how to invest your money, you face a multitude of questions. What kind of investment do I like? What can get me the greatest return? How much should I invest? Am I conservative or a little adventurous with my money? The list goes on and on.

While we cannot address all of those questions in one article, let’s look at some factors you need to think about as you determine where to put your money. No matter what you do with your investments, there are three main factors that will affect your return no matter where you invest your money:

  1. Asset Allocation
  2. Taxation
  3. Expenses

Asset Allocation

Asset allocation is following the old saying of not putting all of your eggs in one basket.  You want to balance risk versus reward by having an investment portfolio with a certain percentage of your money going to each investment type that you choose. Your risk tolerance, goals, and investment time frame come into play as you decide on your investments.

The general types of investments to choose from are stocks, bonds, real estate, cash, commodities, and cash-value life insurance. Each of these has pros and cons that will weigh on you depending on what your attitude toward investing is. For instance, investments can have high risk or low risk. You have to figure out where your comfort level is on that score. You also have to weigh the liquidity of your investment. This is how quickly you can convert your investment into cash without losing your principal. That can be an important factor depending if you are investing for the short-term or long-term.

To help balance out your investments, it is a good idea to select a variety of vehicles in which to place your money. Ray Dalio, the founder of the world’s biggest hedge fund firm, Bridgewater Associates is the 25th richest man in America and 48th in the world according to Forbes’2016 lists. He has been investing since he was 12 years old and is famous for his “All Weather Portfolio” investment philosophy.  This concept balances out the different pros and cons of each type of investment. This “All Weather Portfolio” has produced a 10% return with an average loss of just under 2%. He breaks down the portfolio and suggests you put 30% in stocks, 15% in intermediate-term bonds (7 to 10 years in maturity), and 40% in long-term bonds (20 to 25 in maturity). The stability of the bonds counters the volatility of the stocks. He rounds out the portfolio with 7.5% in gold and 7.5% in commodities. The reason is that you want your portfolio to have a hedge against inflation, and rapid inflation can hurt both stocks and bonds.

While I agree wholeheartedly with Mr. Dalio’s philosophy and asset allocation, my only enhancement will be to use a general account based cash value life insurance as an alternative to long-term bond allocation. It creates tax-efficiency and adds the advantage of death benefits into the equation.

Taxation   

Understanding taxation of your investments is crucial to maximizing returns. Tax efficiency is a measure of how much of an investment’s return remains after you pay taxes on it. When an investment relies on investment income rather than a change in its price to generate a return, it is less tax-efficient for the investor. Tax-efficiency is within reach of most investors. To keep a great percentage of your investment earnings and not raise your tax bracket, choose investments that minimize the tax burden relative to their interest income or dividend income.

Fees

 There are fees in any investment. In just about every type of investment mentioned here, there are both clearly defined charges and those that are hidden. Sometimes you pay them upfront and in other instances, they come off the earnings as an asset management fees. There could be annual or quarterly fees.  In fact, there are many kinds of fees that you pay when you investment your money. Once you know the real return of these various asset classes, you will understand the importance of minimizing fees on your investment as there is not much room. The fees are affecting substantially to your investment return.

The following chart is the comparison of the main six asset classes by the average long-term return, risk category, liquidity, and tax efficient yield. Expenses are not listed since that variable fluctuates greatly between companies. This does give you a general picture of what to expect, but it is always best to talk to discuss specifics with your financial advisors and what works best for you.

Asset Class Long Term Return Risk Liquidity Taxable or Tax-free
Stocks 6% Very High Very Low Taxable
Bonds 4% Low Medium Taxable
Real Estate 5% High Very Low Taxable
Cash 2% No Risk Very High Taxable
Commodities 6% Very High Very Low Taxable
GALIP Cash Value Life Insurance 4% Low Medium Tax-free