Getting 10%: Great Returns of 1%, 5%, 10% and More on Your Money

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As a result, whenever a saving plan is being chalked out, inflation is one of the factors that has to be taken into account. Conversely, if you want to determine the purchasing power of the same Rs 10, in future, keeping all the other parameter as before, the formula is Generally, an investment's annual rate of return is different from the nominal rate of return when compounding occurs more than once a year quarterly, half-yearly.

The formula for converting the nominal return into effective annual rate is If an investment is made at 9 per cent annual rate and compounding is done quarterly, the effective annual rate will be. Thanks to the power of compounding, the effective annual rate of the fixed deposit turns out to be 9. Rule of 72 refers to the time value of money. It helps you know the time in terms of years required to double your money at a given interest rate.

That's why it is popularly known as the 'doubling of money' principle. This is used to indicate the return on an investment over a period. The benefit of using this parameter is that it provides a smoothed-out return over a period, ignoring volatility.

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There are three components that make up CAGR - beginning value, ending value and number of years. The equation is presented as:. This comes to Let's compare Case I's performance with another instrument whose value rose from Rs 10, to Rs 20, in two years. Hence, if you have to compare the performance of any two asset classes or check returns from an investment over different time frames, CAGR is the best tool as it blocks out all the volatility that can otherwise be confusing. Equated monthly instalments EMIs are common in our day-to-day life.

At the time of taking a loan, we are shown a neat A4 size paper explaining the EMI structure in a simplified manner. It is generally an unequal combination of principal and interest payments. We absorb these details and move on with life. But have you ever wondered about the calculation behind these numbers? If you are curious, then here is the formula. We all save small amounts at fixed intervals for a goal. This article emphasizes seven themes:. Visit the Master Case Builder Shop.

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  • T he name of the return on investment metric describes its meaning. It is not surprising, therefore, that businesspeople use ROI to address questions like these: "What do we receive for what we spend? Also, "Do the returns justify the costs? The simple ROI metric answers these questions by making a ratio or percentage , showing the size of net gains relative to the size of total costs directly. As a result, when different proposals compete for funds, and when other factors between them are truly equal, decision-makers view the option with the higher ROI as a better choice.

    Decision-makers should know that ROI figures alone are not a sufficient basis for choosing one action over another. That is because ROI shows how returns compare to costs only if the hoped-for results arrive. The ROI figure, therefore, shows expected profitability but says nothing about uncertainty or risk. Consequently, the wise analyst also estimates the likelihood of different ROI outcomes, and wise decision-makers always consider both the size of the metric and the risks that come with it.

    A nalysts usually present return on investment as the return net gain due to an action divided by the cost of the act.


    To find simple ROI, divide the net gains from the investment by the investment costs, then report the result as a percentage. The return on investment formula seems simple, but usage is not always as straightforward as it looks. The real challenge in finding ROI for any investment or action is knowing which costs and which return figures to use in the formula. Note especially: Results such as the In complicated business settings, however, it is not always easy to match specific returns such as greater profits with the specific costs that bring them such as the costs of a marketing program.

    As a result, when the match between "returns" and "costs" is doubtful, the ROI metric loses validity as a guide for decision support. ROI validity also suffers when the cost figures include allocations or indirect costs, which are probably not due to the action. S ections immediately below show how ROI metrics compare two investment cases that are competing for funding.

    Comparisons of this kind turn up when decision-makers must prioritize incoming proposals to choose those that will justify their costs. At the same time, they will deny funding to those that will probably bring smaller returns or even a net loss. As a result, Capital Review Committees, Project Management Officers, strategic planners, and others, routinely turn to metrics that take an "investment view," of proposed actions. When using ROI to compare two proposals, other things being equal, decision-makers will probably choose the option with the higher ROI.

    Note especially that other examples in sections further below compare these cases again, using ROI along with five other metrics. The purpose of the multi-metric comparison, therefore, is to show that different "metrics" can reach opposite conclusions on which case represents a better business decision. Which is the better choice in business terms?

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    Comparing two cash flow streams: One investment has greater returns early, while the other has substantial returns later. As a rule, decision-makers usually consider several financial metrics, not just one, when making important decisions. Consequently, to answer the question, "Which is the better business decision? Examples below will show, by the way, that Alpha's cash flow stream has a problem that is hidden by the net cash flow figures. Among these metrics, only ROI reveals this problem. Later sections show that ROI's unique insight has to do with the difference between profits and profitability.

    To produce simple ROI, the analyst must have cash inflow and cash outflow data for each period, not just net cash flow values. The data tables above, therefore, must add columns with these figures, as well. Thus, with inflows and outflows now in the first two columns, the tables suffice for producing proper ROIs. Decision-makers should note especially, however, that metrics built from these numbers are "proper"—have clear meaning—only if the analyst confirms that these cash flows are due to the investment or action, and not to other causes.

    The right column of the tables has the simple ROIs as they stand at the end of each yearly period. Note especially: that individual cash outflows costs for Years appear both above the line and below the line, while cash inflows for Years appear only above the line. As a result, annual net cash flow figures alone do not suffice for producing ROIs.

    They are not sufficient because they hide the component inflows and outflows. Using simple ROI as the sole decision criterion, which choice, Alpha or Beta, is the better business decision? The question equates to asking "Which case has the better returns compared to costs? Note especially that simple ROI derives from periodic inflows and outflows, not from net cash flows. Return on investment reveals that difference. The differences between profits and profitability can be significant for several reasons, which means, therefore, that some analysts consider an ROI figure mandatory for every investment review.

    Option Alpha may become less attractive in the investor's eyes, for instance, because he or she must first budget and pay for Alpha's more substantial total costs, no matter how large the incoming returns. As a result, the business decision maker may be unwilling or unable to do so. T he use of ROI is usually legitimate when the metric can usefully address questions about investments and decisions such as these:. Also, however, it is important to remember to use ROI only when the appropriate cash flow data for calculating the metric are available. In brief, this means that ROI is legitimate only when all investment costs cash outflows and all returns cash inflows are known.

    Regarding input data for the metric, therefore, it is helpful to two consider two different situations:. For simple action scenarios with only one cash outflow and one cash inflow, ROI data needs are elementary. Here, the analyst needs only two numbers:. What is the return on investment for a gambler's winning bet on a horse race?

    The Present Value and Future Value of Money

    Then, a few minutes later, horse 4 finishes first. The pay off for a winning bet depends of course on the "odds" in effect when betting windows close. The resulting ROI, therefore, also depends on the betting odds and the bettor can say, correctly, that these odds are the same as the ROI for this bet. Both events are due to the investment, and the ROI meaning is therefore valid. Second, the degree of organizational disruption caused by your reductions will usually be proportional to the degree of cutting you do. Therefore, you should tailor the reductions you pursue to your savings goal.

    The following kinds of reductions are most common:. Combine activities like training days and celebrations into single events. Combine events across multiple departments. Cross-schedule the use of outside resources, such as facilities or trainers. Combine activities like training days and celebrations into single events, and cross-schedule the use of outside resources.

    All administrative departments, efficient ones included, have unresolved personnel issues. After you have exhausted the common ploy of claiming cost savings by leaving vacant positions unfilled, you should restructure the jobs of any less-than-fully-busy people and confront the problem of underperformers. The first is usually easy to spot: These workers spend the most time in the halls.

    They organize the office birthday parties. Perhaps their jobs were made simpler by the new online HR or finance system a year ago, and new duties were never assigned. The second type includes employees who do both unpleasant but valuable tasks and pleasant but less valuable ones.

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    Any efficiency gains in the former part of their job tend to get offset by excessive focus on the latter. Such was the case for branch officers at a bank we worked with a few years ago. The company had spent millions of dollars making the sales process more efficient, yet sales did not grow. We discovered that the officers devoted their freed-up time to better serving existing customers and reading up on new products—but not to phoning customers and selling which they enjoyed least.

    Every department seems to have one or two of them. Admit it: You already know who these people are. In two more years, you may not be able to protect them any longer. They will be two years older, which may make it harder for them to get comparable positions elsewhere. But you can find ways around those barriers. Because the job requirements were new, past HR ratings did not matter. He created a process to ensure that the people best qualified for the new jobs got them; the others were released.

    Determine which parts of your department are performing essentially the same tasks they were a year ago. At one bank, we found that oversupervising the tellers actually cost the organization doubly: It had to compensate the managers and pay for the lost time that tellers spent discussing with their bosses matters that could have been handled independently. But to gain value from this reduction, you must increase the individual contributions required of the supervisors.

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    Organizations and departments trying to cut administrative costs often leave management untouched—missing out on big potential savings. This makes for narrow spans of control, especially when subordinates are doing distinct, specialized tasks. After that, the savings potential is simple math:. Click here for a larger image of the graphic.

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    Its spiritual cousin—a riding lawn mower named Typewriter—was found in the maintenance department. Though this idea seems obvious, it is usually overlooked. Check with HR to see where your employees stand relative to the marketplace. Now is the time to repropose those ideas. Strive to eliminate any work for which the cost exceeds the value—keeping in mind that it surely has some value. You should strive to eliminate any work for which the cost exceeds the value keeping in mind that it surely has some value and that cutting it will cause a certain amount of discomfort.

    This will allow you to separate the decision to eliminate tasks from the identity of the individuals who conduct them. You can then determine which people are best suited for the new jobs. How is the workload of your department shaped by other groups in the organization?

    Is your role to provide information to them, for example, or to process or store information generated by them? Do their deadlines and requirements exacerbate your workload? If so, cost has a reasonable chance of exceeding value at the consolidated-organization level , because the department requiring the work does not directly bear the cost. You assume that the counterparty values the work highly enough to justify your efforts, but that may not be the case.

    Therefore, you should disaggregate your efforts as much as possible—for instance, by geography and product line—and then verify that each part of your effort is justified. This approach can reveal several kinds of opportunities, such as:. Multiple studies have shown that this assumption is often wrong. Coordinators were valuable to departments whose operations were spread around the country but less so to those nearby. Do you prepare long reports with comprehensive data when only exceptions matter or when the true consequences of variances are quite small?

    Do you prepare reports that cover short periods of time or are delivered in real time, when longer periods or slower reporting would meet the need just as well? Often, internal administrative processes become frozen—despite the fact that, over time, they may cease to be efficient or effective. Asking questions in four areas can help you understand whether this has occurred in your department and whether you can cut expenses accordingly:. How have the business requirements evolved since you last fundamentally redesigned the process?

    Perhaps the need for certain data has diminished or disappeared altogether. Where do you use people to process forms or information repetitively, rather than do it electronically, with little or no human intervention? What would it take to do away with the exceptional ones?