New Here? Get the Free Newsletter

Oblivious Investor offers a free newsletter providing tips on low-maintenance investing, tax planning, and retirement planning. Join over 21,000 email subscribers:

Articles are published Monday and Friday. You can unsubscribe at any time.

Fundamental Factors in Determining Investment Return

As you know, the whole point of this blog is to encourage people to focus on the basics of investing while ignoring everything else. So for today we have the two fundamental factors in determining investment return.

  1. How much money is the investment expected to pay?
  2. How predictable is the payout?

It really is quite simple, but a little explanation probably wouldn’t hurt.

How much will the investment pay?

We’re not talking about a rate of return here. We’re talking about an amount of money. For example, a bond might be expected to pay $500 every 6 months for the next 10 years.

Of course, with many investments, this is clearly an estimate. For example, we can see that a given stock is paying X dollars in dividends each quarter, but we then have to make guesses as to whether that amount will increase, stay the same, or decrease.

How predictable is the payout?

All else being equal, investors will pay more for an investment that will reliably pay $500 per year than they will for an investment that will perhaps-pay-somewhere-around $500 per year. And that makes perfect sense.

As a result, the investment with the reliable payout will have a lower rate of return. (Paying more for a given payout by definition means a lower rate of return.)

All the factors that might make the payout on an investment less predictable are what are known collectively as “risk” (according to the traditional technical definition).

How to take advantage of this knowledge

Here’s the most important part: When investors consider the predictability of an investment’s payout, they look almost exclusively at short-term predictability.

As a result, stocks (unpredictable over the short-run) end up being priced such that they have a greater rate of return than bonds (fairly predictable over the short-run) and a much greater rate of return than CDs (very predictable over the short-run).

What’s so great for long-term investors, though, is that long-term stock payouts (for big enough groups of stocks, anyway) are actually relatively predictable. And this “high return plus predictable payout” is precisely what makes stocks so great for long-term investors.

Hopefully, if we can keep in mind the fact that there are fundamental reasons why stocks will earn more than other investments over extended periods, we can do a better job of keeping our heads during down markets. 🙂

New to Investing? See My Related Book:

Book6FrontCoverTiltedBlue

Investing Made Simple: Investing in Index Funds Explained in 100 Pages or Less

Topics Covered in the Book:
  • Asset Allocation: Why it's so important, and how to determine your own,
  • How to to pick winning mutual funds,
  • Roth IRA vs. traditional IRA vs. 401(k),
  • Click here to see the full list.

A Testimonial:

"A wonderful book that tells its readers, with simple logical explanations, our Boglehead Philosophy for successful investing." - Taylor Larimore, author of The Bogleheads' Guide to Investing
Disclaimer: By using this site, you explicitly agree to its Terms of Use and agree not to hold Simple Subjects, LLC or any of its members liable in any way for damages arising from decisions you make based on the information made available on this site. I am not a financial or investment advisor, and the information on this site is for informational and entertainment purposes only and does not constitute financial advice.

Copyright 2020 Simple Subjects, LLC - All rights reserved. To be clear: This means that, aside from small quotations, the material on this site may not be republished elsewhere without my express permission. Terms of Use and Privacy Policy

My new Social Security calculator (beta): Open Social Security