A reader asks: “Is it possible to get a 10 per cent return in a balanced fund [see last week’s article] in this environment? I once read that using the Rule of 72, with a 10 per cent return, my retirement portfolio would double in value in a little over seven years. Since my retirement rainbow is ten to 15 years away that would be triply, simply perfect.”

Answer: of course, one can invest for a 10 per cent return, but there are risks which are generally not well understood.

But you almost certainly won’t find that kind of a return by investing in the standard savings (fixed, term) deposit structure in today’s finance environment of zero to negative interest rates. Everyone can take that as a frustrating given.

Those who can still fondly remember the days of deposit rates of between 7 per cent and 9 per cent in Bermuda, or even further back to the early 1980s when the United States Federal Prime Rate was at a record high of 21.5 per cent, still wish it could be that easy.

Readers, remember our current low interest rate environment and beware of advertisements that tout a 20 per cent return on your invested capital in a year, or more astonishingly, every month. Your first question should always be: how can this investment scheme pay such high rates when no one else can?

How does the Rule of 72 work?

First, you should know that the Rule of 72 and investment appreciation/depreciation derived from capital markets are not the same.

The Rule of 72 is a straight-line, mathematic calculation where every year the principal amount increases. Generally, the Rule of 72 is based on the concept of compounding interest requiring three factors: the interest rate, the principal amount to be compounded and time (the number of years). Thus, if you opened a term deposit of $10,000 for say five years at a 7 per cent interest rate, compounded annually, you know at the term limit you will have $14,026. But the deposit has not doubled in value? It will take a little over ten years to double. Shortening the whole boring and confusing equation, all you have to do is divide the interest rate into 72. Presto. Therefore, 72 divided by seven equates to 10.2 years.

The compounding concept

Each year the amount of interest earned is added to the principal and the total sum is recalculated. See the chart for a clear illustration of how this works. Amortised mortgage payments are calculated the same way, but in reverse, because your principal is being reduced.

Investing in capital markets is far removed from accruing your cash in a savings accounts.

The investment process on a simplistic basis converts your cash to shares of securities: bonds, stocks, mutual/hedge funds, real estate trusts, private equity, and so on. These shares trade in open investment markets. Share prices fluctuate in these markets according to values placed on them by any number of investment, economic, interest rate, risk measurement, global episodes or other criteria.

A great upward share valuation trending day can drop overnight, but in general, over the long-term, good investments appreciate in value. Capital market activity is not predictable on a straight-line Rule of 72 calculation, and therein lies the risk of investing — what you see is not always what you will ultimately get.

Go to your favourite search engine and type in the same 10 per cent return reader question. Golly, a mere 250 million sites popup, with article titles such as: “Ten ways to get 10 per cent return on your investments; Six steps to financial freedom; Earn an easy 10 per cent return without buying any stocks.”

These headlines tend to increase investor optimism because the process seems so easy. Now, your humble servant will offer my cynical two cents worth. I am no big name investment headliner, nor do I sell any investment products. Thank goodness, since the pressure to produce decent investment returns and analyse the next market direction or hot sector would reduce me quickly to an incoherent state.

Ladies and gentlemen, in this still recovering global economy, managing for a 10 per cent investment return on a consistent long-term basis is challenging and not without risk.

Zero Hedge* last week commented on a Callan Associates research report that illustrated twenty years ago how a 100 per cent bond portfolio could produce an expected return of 7.5 per cent with a standard deviation of 6 per cent. In 2015, in that hypothetical portfolio, in order to achieve the same 7.5 per cent expected return the bond allocation would have to drop to 12 per cent with the remaining 88 per cent positions in risker assets along with an almost three times higher (17.2 per cent) standard deviation.

Standard deviation, by the way, means the measure of dispersion around a set of data from its mean. Standard deviation in finance is a measurement of an investment’s volatility in price at any given calculated time.

Here are some interesting comparisons. Average performance over the last ten years, with values taken from several large fund company profiles.

• Balanced fund from 5.4 to 5.9 per cent, and higher, depending upon the stock allocation

• Large cap stock growth from 8.4 per cent and upwards (remember, 2009 stocks outperformed the market with gains of more than than 20 per cent).

• High-yield bond funds from 6 per cent to 8 per cent and higher, with higher risk too.

The truth is this, don’t we wish we could all get a 10 per cent return with little to no risk, particularly on a consistent basis? Just think, you would never have to read my articles again, or worry about planning for retirement. After all, a 10 per cent return divided into 72 = means doubling your money in 7.2 years. A 20 per cent return, well you do the math!

So, what is the answer? Is a higher risk, higher return strategy worth the anguish for the individual investor? Can our reader increase his return on investments? Can he double or triple his money in 15 years? Perhaps, with a more aggressive riskier portfolio allocation.

Only you can decide what to do. The alternative is to structure your lifestyle for a minimally satisfactory level, save as much as you can, work as long as you can. If it makes you feel any better thousands of us struggle with this frustrating decision.

* The Zero Hedge link is http://www.zerohedge.com/news/2016-06-01/welcome-new-normal-where-3x-more-risk-gets-you-same-returns-twenty-years-ago

Martha Harris Myron CPA PFS JSM, Masters of Law: International Tax and Financial Services. Appointed to the Professional Tax Advisory Council, American Citizens Abroad, https://americansabroad.org/. The Pondstraddler* Life™ financial perspectives for Bermuda residents with multinational families and international connections on the Great Atlantic Pond. Contact: martha@pondstraddler.com