What risk means and what return expectations are realistic

But what exactly is risk and what return expectations are realistic? Without a viable definition, every investment concept is built on sand. In addition, some terminology needs to be explained.

How is the return calculated?

The return for past observation periods can be calculated easily. In most cases, the annual return is given. This can be defined as the percentage change in the value of the investment over a one-year period. All return components, but also possible costs and losses, must be taken into account.

The return on securities is made up of price changes and interim cash inflows (interest coupon, dividend, subscription rights, etc.). Costs and losses can arise, for example, from exchange rate losses incurred when funds invested in foreign currency via https://exness-ar.com/tnzyl-exness/ are exchanged in the meantime - and of course from price losses in the security itself.

Nominal yield, real yield, net yield

A simple calculation example should clarify the difference between nominal, real and after-tax returns. The following parameters are used: 

•     Share price on 01 January (purchase date): 100 EUR
•     Share price on 31 December (date of sale): 105 EUR
•     Dividend: 5 EUR
•     Inflation rate: 3%
•     Tax rate: 28

The shareholder's account contains 110 EUR on 31 December, which is 10% more than on 01 January. In this case, half of the nominal yield of 10% is made up of price gains and half of dividend inflows. However, the significance of the nominal yield is limited. Ultimately, the net real return is decisive.

To determine this, the first step is to take into account the claims of the tax office, which subjects the nominal return to taxation. The tax rate of 28 percent selected in the example leads to a tax payment of 2.80 euros. The nominal after-tax return is therefore 7.20 per cent. From this, in turn, the loss of purchasing power incurred by the investor during the investment period must be deducted. Usually, the official inflation rate is used for this purpose. If this is 3.00 per cent, as in the example, the real return after tax is reduced to 4.20 per cent - which corresponds to less than half of the nominal return before tax.

Taxes, inflation and compound interest effect

The effects are much greater still when longer investment periods are considered. An annual return of 10 percent leads to a total return of almost 160 percent within ten years if the income is fully reinvested: under these conditions, 100,000 euros become 260,000 euros, calculated as 1.10 to the power of 10. If taxes are deducted and inflation is taken into account and the net real return of 4.20 percent is used as a calculation value, the total return after ten years is almost 51 percent: 100,000 euros become 151,000 euros. The nominal return before taxes is thus more than three times as high as the real return after taxes.

There are countless calculation tools on the internet that enable calculations of this kind in detail and with many more variables. On Brokervergleich.de you will find a tool for calculating the return.