The Pros And Cons Of Rate Of Return

811 Words 4 Pages
Often the lay person who has a limited understanding of investing will lump stocks and bonds together when talking about investing in markets. While they do share some similarities, there are also significant differences one needs to be aware of, such as how the investment works, the outside forces that influence value, liquidity, and the markets where they are traded. It is also important to understand rates of return, so I shall include multiple examples using a stock with and without a dividend component.
Stocks are probably the most easily understood by the novice investor and are a market that is accessible by almost anyone. There are dozens of online brokerage services that make investing in stocks easy and convenient. To put it simply,
…show more content…
((Current value - Cost) / Cost) x 100 = rate of return. (Rivers, J. p.4) The piece that is often overlooked is the cost of the purchase and sale of the shares.

As an example is one where to buy a single share of a company for $100 and sell the stock for $105 without any fees our rate of return would be 5%. If we do the same trade but we are charged $5 to buy the stock and another $5 to sell the stock the actual cost is $105 and the effective sale price is $100 and our rate of return is -4.76%.

Sometimes we may choose to buy a stock that earns dividends. Most dividends are paid quarterly and for the purposes of the exercise let’s say this stock pays fifty cents per share per quarter and after one year is has earned $2. We bought the stock at $100 and sold it 1 year later at $105 and we did not incur any trade fees. In this case, we would have an ROI of 7%. Unfortunately, the real world would have fees at both ends of the transaction and our actual rate of return would be more like a cost of $105 and a final sale price of $100 after the cost of the trade at $5 plus the dividend of $2, resulting in a loss of

Related Documents