Understanding the Target Rate of Return
The Target Rate of Return (TROR) is a crucial metric for investors, helping them set realistic financial goals and evaluate the performance of their investments. It represents the minimum annual percentage gain an investor expects or needs to achieve from an investment over a specific period to meet their financial objectives.
Why is TROR Important?
- Goal Setting: TROR allows investors to quantify their investment aspirations. For example, if you want to grow $10,000 to $15,000 in 5 years, your TROR calculation will tell you the annual return you need to aim for.
- Investment Selection: By comparing potential investments' expected returns against your TROR, you can make more informed decisions about where to allocate your capital.
- Performance Evaluation: It provides a benchmark against which to measure the actual performance of your portfolio.
- Risk Management: Understanding your required return can influence your risk tolerance. Higher required returns often necessitate taking on higher risks.
How to Calculate Your Target Rate of Return
The formula to calculate the Target Rate of Return is derived from the compound annual growth rate (CAGR) formula, rearranged to solve for the rate of return.
The formula is:
TROR = [(Desired Future Value / Current Investment Value)^(1 / Time Period in Years)] – 1
Let's break down the components:
- Current Investment Value: The initial amount of money you have invested or are planning to invest.
- Desired Future Value: The target amount of money you want your investment to grow to by the end of the time period.
- Time Period (Years): The duration over which you expect your investment to grow.
Example Calculation:
Suppose you have a current investment of $10,000 and you want it to grow to $15,000 in 5 years. To calculate your target rate of return:
- Current Investment Value = $10,000
- Desired Future Value = $15,000
- Time Period = 5 years
TROR = [($15,000 / $10,000)^(1 / 5)] – 1
TROR = [(1.5)^(0.2)] – 1
TROR = [1.08447] – 1
TROR = 0.08447
To express this as a percentage, multiply by 100:
TROR = 8.45%
This means you need your investment to grow by an average of 8.45% per year to reach your goal of $15,000 in 5 years.
function calculateTargetRateOfReturn() {
var currentInvestment = parseFloat(document.getElementById("currentInvestment").value);
var desiredFutureValue = parseFloat(document.getElementById("desiredFutureValue").value);
var timePeriodYears = parseFloat(document.getElementById("timePeriodYears").value);
var resultDiv = document.getElementById("result");
resultDiv.innerHTML = ""; // Clear previous results
if (isNaN(currentInvestment) || isNaN(desiredFutureValue) || isNaN(timePeriodYears) ||
currentInvestment <= 0 || desiredFutureValue <= 0 || timePeriodYears <= 0) {
resultDiv.innerHTML = "Please enter valid positive numbers for all fields.";
return;
}
if (desiredFutureValue <= currentInvestment) {
resultDiv.innerHTML = "Desired Future Value must be greater than Current Investment Value.";
return;
}
// Calculate Target Rate of Return
// TROR = [(Desired Future Value / Current Investment Value)^(1 / Time Period in Years)] – 1
var exponent = 1 / timePeriodYears;
var ratio = desiredFutureValue / currentInvestment;
var targetRate = Math.pow(ratio, exponent) – 1;
var formattedTargetRate = (targetRate * 100).toFixed(2);
resultDiv.innerHTML = "
Your Target Rate of Return:
" + formattedTargetRate + "%";
}
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