How to Calculate the Required Return on Stocks
Original post by Mark Kennan of Demand Media
If you are investing with a specified goal in mind, such as saving for retirement or your child's college education, you can calculate the required rate of return for stocks so that you will achieve your savings goal. When you know your required rate of return, you can target your investments. For example, if you need a lower rate, you can target less risky investments, but if you need a higher rate of return, you may be willing to accept a higher risk level.
Divide the desired ending value by the amount of money you are going to invest in stocks. For example, if you have $10,000 to invest and you want it to grow to $21,000 in 12 years, divide $21,000 by $10,000 to get 2.1.
Calculate the quotient of 1 divided by the years before you need your stocks to grow to the expected value. In this example, divide 1 by 12 to get 0.083333.
Raise the ratio of the expected stock value to current stock value to the Step 3 result with a calculator. Enter the ratio, push the power button (sometimes a "^" or "x^y"), enter the Step 3 result and push equals. In this example, raise 2.1 to the 0.833333 power to get 1.8557. .
Subtract 1 from the result to find the required annual rate of return on the stock. In this example, subtract 1 from 1.8557 to get 0.8557, meaning your required rate of return equals 8.56 percent.
- Stanford University; CAGR (Compound Annual Growth Rate); Michael Fan; 2006
- Investopedia; Understanding the Time Value of Money; Shauna Carther; September 1, 2008
- Purple Math: Exponential Functions: Compound Interest
About the Author
Mark Kennan is a freelance writer specializing in finance-related articles. He has worked as a sports editor for "Ring-Tum Phi" and published articles on a number of online outlets. Kennan holds a Bachelor of Arts in history and politics from Washington and Lee University.
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