“Hey Mr. Fund Manager, so what’s the best performing fund that I should invest in? I want to invest in the product that gives the highest returns”.
Anyone in the financial services industry would have heard these questions over and over again in the course of interacting with clients. It is obvious that majority of investors are primarily fixated on potential return on investments (ROI) when deciding on their ideal investment. Simply put, they want to know, “What can I get out of it?”
This is a perfectly natural question because we tend to quantify things especially if it involves money. A parent who spends a million bucks to put his son through medical school will want to know how much income his son will earn upon graduation. Likewise, an executive considering to pursue an MBA will want to know if it will get him that promotion and salary upgrade.
Seasoned investors will likely tell you that ROI is THE measure of whether your investment returns are good or otherwise. But is that really all there is to it?
What’s Missing from This Picture?
No doubt ROI is by and large the most common and widely accepted way to assess the performance of an investment. And with good reason too. It’s a buzz word that has been around; the man on the street knows it and generally understands it.
Eager sales personnel finds it easy to explain to his customer with bright and shiny brochures and prospectuses showing impressive past performance figures. But the crux of the matter is, regardless of the significance of ROI, it should not be the sole determinant of whether or not one participates in an investment opportunity. Here’s why:
First, let’s take a step back and ask the most basic question in investing. Why do we invest in the first place? We invest because we want to grow our money in order to fund our various financial goals and aspirations. The more money we have, the more likely we are to achieve these desires. In short, we invest to grow our money or more specifically, our net worth.
I was once asked by an area sales manager if we can offer a product to match the ROI provided by a gold investment opportunity, which claimed to offer as much as 2% return per month.
That’s a whopping 24% return per annum! Needless to say, I had to turn down the challenge to source for an alternative investment for this client. Subsequently, news broke that this scheme and many other similar ones were really just too good to be true.
Investors who were chasing the best possible return on investment lost sight of the importance of paying attention to the return of investment! Many investors of these schemes have now written off the possibility of getting back a single sen of their hard earned money from these questionable investments.
So Then, Is Measuring ROI Flawed?
Having spent many years in the asset management industry previously, I have to admit that ROI is an important measure of investment performance. Now, as a licensed independent financial advisor, I also recognise that our clients need to do all they can to ultimately grow their net worth in order to achieve their desired financial goals.
Here’s why ROI based investing comes up short:
ROI is a means to an end, rather than the be-all and end-all
Suppose you were fortunate enough to select an investment product that gave a ROI of 20% after 1 year. If your principal investment amount was RM100k, this would mean that your return on investment would be RM20k (assuming no other investment charges).
However, if you’re a typical middle class Malaysian with a net worth of say RM2 million, the ROI on this investment would only increase your net worth by a meagre 1% (all else being equal).
As a ROI based investor, you’re likely to give yourself a high five on this investment selection. But as you can see, using ROI as your sole investment key performance indicator (KPI) could result in you losing sight of the bigger picture and growing your net worth in isolation. A strong ROI is good, but it is by no means a guarantee of your overall wealth growth.
ROI is only one of many factors in growing net worth
If your ultimate goal is net worth growth, then do pay attention to other factors that affect your overall wealth as well.
- Optimising your savings – it’s important to focus on growing your savings as this is your primary source of investment capital. Are you saving enough to help you invest in order to ultimately meet your desired financial goals? People may say they save, but knowing your optimal savings rate is essential.
- Managing risks holistically – You may manage some investment risks but might have missed out considering other risks associated with investments. Unfortunately, investment gains can be quickly offset by the impact of currency devaluation if not managed well. In addition to investment risks, you will also need to manage other risks that will affect your net worth growth like liability risk, country risk and premature death.
- Managing costs – if you don’t sufficiently consider the cost of investments, this can eat away at your potential investment returns over time. There are other costs to be mindful of also such as insurance premium cost, mortgage interest cost, estate administration cost and many more.
An Alternative Approach
Given the potential risks of relying on ROI alone, is there an alternative approach? I would opine that net worth growth is the better way to evaluate the impact of your investments in growing overall wealth.
With net worth growth in mind, an investor seeks to increase, manage and measure one’s wealth by considering every factor as a whole instead of looking at these factors in isolation. In addition to ROI and investment risks, net worth based investing looks at minimising overall risk and optimising net worth growth in key areas of personal finance such as retirement planning, child education planning and estate planning.
Suffice to say, net worth based investing empowers one to invest with confidence and clarity instead of being anxious, confused or even stressed out once you’ve already identified and considered all factors that affect your net worth in the long run.
ROI has been a key benchmark in determining investment performance for good reason but in reality, it comes in short when used as the only measurement of investment performance. You risk chasing after smaller wins while losing sight of the big picture impact that these investment decisions may have on your ultimate goal – that is to grow overall wealth.
So, yes – pay attention to ROI but remember that in the end, your net worth is your true indicator of your ability to achieve financial freedom.
Felix Neoh is a licensed independent financial advisor with Whitman Independent Advisors. He seeks to use his 20 years of experience in banking and asset management to help more middle class Malaysians to achieve financial freedom.