The topic usually comes up when one of my friends is starting on their third glass of wine. (And they consumed a lot of wine at our house over the holidays.) They begin to complain that they are not making enough on their personal investments.
“I know. I know,” they always say. “If I want to make more money, I need to make more risks. But I wish it didn’t have to be that way.
Well, there is a way to do it without increasing the risk. It isn’t hard. It just takes discipline and a quick review of the basics. Since we are talking about increasing returns on investment, that is the place to start, with the formula that determines ROI.
You know the formula: Income divided by investment
Let’s deal with the way ROI is traditionally used—in business—to make sure we are all on the same page, then we will show you how you can think about it differently when it comes to your personal investments so that you can generate more income without increasing your risk.
When businesses talks about increasing ROI, the focus is invariably on the denominator: How can we obtain our current level of earnings (or more) by making less of an investment? Asking that question that way makes perfect sense, of course, because it allows you to increase your profits substantially. It’s a great way to make a lot of money.
Let’s say your company receives $20 in earnings for every $18 in investment it makes. (Add a whole lot more zeroes to both the top and bottom lines if you think the example is too simplistic.)
———- = 11.11% ROI
Your return on investment is 11%.
If you find a way to cut investment by just $1, and still get that same $20 in earnings, your return jumps to almost 18%….
$20 in Earnings
———- = 17.6% ROI
…and you look like a hero. That’s why everyone thinks about cutting costs (i.e. investment), when the discussion turns to ways to increase corporate ROI.
How does this affect you and your investments? That’s simple. All we have to do is flip the emphasis in the formula.
As we have seen, the formula has three parts: earnings; investment and ROI.
Traditionally you would try to increase your yield—the numerator. You have $100,000 to invest and if you get 7.5% on your money instead of 6%, you would make $7,500 or an extra $1,500 a year.
So far, so good.
But, suppose you didn’t want to take the increased risk that comes with chasing increased yield. (And it is always the case, the higher the yield, the higher the risk.)
Another way to increase the amount of money you earn is by increasing the denominator—the amount of the investment. Instead of investing $100,000, suppose you got that number up to $125,000 and you earned that same 6% you were making before.
Your yield would be $7,500—.06 x 125,000–and you haven’t taken any more risk.
True, this way you have to work a bit harder to save more money. But you will have increased your return without adding any risk. That is certainly something worth thinking about as we start 2017.