Why Chasing Returns Will Burn You

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Aren’t you looking for higher returns right now? Who isn’t?

Here are some popular options to earn some sort of return these days:

Photo by Karah Levely-Rinaldi via Flickr

• ING Direct savings interest rate: 0.85%
• Average brick and mortar savings interest rate: 0.20% or less
• A high yield bond fund: 4%
• A utility company stock with a dividend: 4%

As you can see the options aren’t very attractive. That leads to the want or need of higher returns, and the search is on. We’ll look anywhere to satisfy this need… financial magazines, mainstream blogs, niche paid newsletters, and friend-of-a-friend recommendations.

But be careful! Chasing returns can and will burn you… badly.

Two Reasons Chasing Returns Will Hurt Your Portfolio

There are two main reasons that only focusing on earning the highest returns will, in the long run, do more harm than good.

Higher Return, Higher Risk

Keeping a constant focus on earning the highest return seems like a good idea. We could all use a few extra percentage points this year, right? But chasing the best returns is different from the highest returns.

With high returns comes high risk. A few years ago several real estate investment trusts (REITs) were offering dividend yields in the 10-15% range. Many investors hopped on the eye-popping returns only to lose 100% of their investment when the company went belly up during the housing crisis. The stock market is the culmination of the idea that with higher risk come higher returns. If you chase higher returns by buying individual stocks you could win big, but you could also lose big, too. High returns inevitably come with high risk. The more exotic the investment, the higher the risk, and the more enticing it can be. You might be able to get great returns by dumping money into that new condo building going up — the guy pitching you seems really honest, so why not? — but it might cost you everything you have, too.

Misplaced Focus

Focusing only on the highest returns possible is a misplaced focus. These are three areas that make sense for most investors to focus on:

• Accept Average: With investing, being average is great. That means using index mutual funds so that you earn whatever the index earns. You avoid the ups and downs of actively managed funds.
• Lower Expenses: With index funds comes lower mutual fund expenses. Even if you aren’t using solely index mutual funds (maybe ETFs come into the mix for you), a focus on lowering your expenses is one of the only ways to truly save money when investing.
• Consistent Investment: Being consistent in your investments is much more important than squeezing the highest returns from fewer investments. You can’t squeeze blood from a rock, and you can’t squeeze $1,000,000 in returns from a $5,000 Roth IRA investment. You’d be much better off setting up a system to consistently invest $5,000 every year so that, over time, you get to that $1,000,000 mark.

I mentioned earlier that chasing the best returns is different from chasing the highest returns. The best returns are those above: an average return with minimal expenses. That strategy mixed with consistent investment is the best return you could ask for.

This article is by our Senior Editor, Kevin Mulligan. He is a debt reduction champion with a passion for teaching people how to budget and stay out of debt. Kevin’s been utilizing a Roth IRA to save for retirement since 2008.