Investing can seem complicated. There are endless charts, forecasts, financial experts and promises of huge returns. But understanding your money really comes down to two questions.
Looking back: how much did I actually earn after fees? Looking ahead: how much can I reasonably expect to earn after fees?
The first tells you whether your investment has done well. The second helps you decide where to put your money.
1. What did I actually earn?
When an investment manager tells you a fund returned 15%, ask how much landed in investors’ pockets. Investment fees can range from less than 0.1% to more than 5% a year. Management fees, platform charges and transaction costs all eat into your returns.
Take two investments that both earn 12% before fees. One charges 1% and the other 3%. Your returns are roughly 11% and 9%. That sounds like a small gap, but it adds up.
Invest R100,000 for 20 years. At 11%, you end up with about R806,000. At 9%, you get just R560,000. That is R246,000 less, simply because of higher fees.
Always ask for the annualised net return. This is what your investment actually earned each year after costs, and it lets you compare investments fairly.
2. What can I expect to earn?
Past performance is useful, but it does not tell us what happens next. For that, we need to understand expected returns.
Don’t let the term put you off. Expected return is simply the average result you can expect across different possible outcomes, based on how likely each one is.
Say an investment has a 50% chance of gaining 20% and a 50% chance of losing 10%. Its expected return is 5%. You may not earn 5%. You might gain 20% or lose 10%. But 5% is what you can expect on average.
Expected returns must also be worked out after fees. An investment expected to earn 8% before fees, with a 2% charge, has an expected net return of roughly 6%.
3. Why this changes everything
Expected returns should guide where you put your money.
Take online gambling. The games are built to give the operator an edge. You might win today, but the expected return for the player is negative. Play long enough and the maths favours the house. You will lose.
At the other end are low-cost ETFs that track an index. They invest in a spread of company shares, and their expected returns follow the long-term performance of those businesses. Losses are possible, but companies that make profits and create value give you a solid base for positive returns over time.
The lesson is simple: don’t confuse the possibility of making money with the probability of making money. You could win the Lotto, but you probably won’t.
A wise investor looks for positive expected returns, weighs the risks and keeps costs low. Building wealth is not about getting rich overnight. It is about making sensible decisions again and again and letting compound growth do the work.
So before you put your money anywhere, ask two questions: what did I actually earn, and what can I reasonably expect to earn?
For more help with managing your money, visit Siza Khula, Scrolla.Africa’s free financial guidance tool.
Thomas Brennan is the CEO of Franc, a financial technology company.
This article is an opinion piece and reflects the views of the author, not necessarily those of Scrolla.Africa. It is intended for general information and does not constitute personal financial advice.
