Following up on Enough Wealth's comments on my previous post, I'm going to do an example here where Yoyo has borrowed money to invest. This could apply for either stocks bought on margin or an investment property bought with a mortgage.
31 January 2007:
Brokerage - stocks and cash: $45,500
Brokerage margin loan: -$10,000
Retirement: $93,000
Total: $128,500
28 February 2007:
Brokerage - stocks and cash: $45,500
Brokerage - margin loan: -$12,100
Retirement: $94,200
Total: $127,600
Yoyo computes the value of her accounts by adding up all the assets and deducting the value of the margin loan. If she invested with Ameritrade for example, she wouldn't even need to do this as they give you the net value of your account already computed. I am assuming that she pays $100 in interest and borrows an additional $2000. It's usual to capitalize all these costs onto a margin loan, so she doesn't even need to do the calculations.
She also collects the following information as before:
February retirement contributions: $550
15 February put $500 into brokerage account
28 February withdrew $600
The calculation proceeds as before:
Investment gain in brokerage account = ($45,500-$12,100)-($45,500-$10,000)-$500+$600 = -$2000
or: monthly change in account value - net contribution to account.
The calculation for the retirement account is unchanged - a gain of $700. Yoyo's net loss is now -$1300.
Her rate of return is now:
ROR = -1300/(45500-10000+93000) = -1.01%
If your broker reports the net account value like Ameritrade does then there is no additional calculation at all compared to the non-margin case.
For an investment property bought on a mortgage, all payments towards paying the mortgage count as contributions. Payments for maintenance, insurance etc. also count as contributions to the account. All my financial investment examples compute pre-tax return so I would not include payments for taxes in the real estate calculation either in order to derive the pre-tax return.
The main point here is that borrowing money or paying off a margin loan by selling stock can be completely ignored when you are calculating return on investment.
One final point - the calculations EnoughWealth gives are annual rates of return. I recommend to first compute monthly rates of return. My examples so far are all for monthly rates of return and are not annualized.
2 comments:
Hi mOOm,
Thanks for the tutorial ;) Seems simple enough when explained that way.
Thanks! Next I'll explain how to compute annualized and annual and longer rates of return.
It's true that computing all this daily would be more accurate than monthly. The small loss in accuracy for most accounts is worth the trade off for something that is much easier to compute I think.
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