Factors that destroy profits

Every starting investor will have to be aware that certain factors will always eat away at rate of returns. These factors are a constant presence and cannot be ignored. If not careful, these factors can diminish yearly returns, which will amount to quite a sum of money in the long run. This article will cover some factors every investor should be aware of.

Transaction costs

Every investor on the stock market will have to deal with transaction costs. Just to get even, an investor will have to gain a profit that covers the transaction costs for both buying and selling an asset. An article about transaction costs and the effect on returns has already been posted on this website: Transaction Costs and Their Effect on Rate of Return.

The bid-ask spread

The bid-ask spread is the difference between the lowest asking price and the highest bidding price. For example, if Apple (AAPL) shares are worth $100 on the open market, the lowest asking price might be $101 and the highest bidding price might be $99. In this case the bid-ask spread is $2. Assets with higher liquidity (ease of selling or buying) tend to have lower bid-ask spreads. The bid-ask spread displays the loss an investor has to take into account when buying or selling assets. If an investor wanted to get rid of his Apple shares with a market value of $100, it would mean he needed to accept the bidding price of $99, which is a $1 loss compared to the market value.

Taxes

For many people taxes are one of the worst inventions ever. Taxes keep countries running though, so they are a necessary evil. No investor will be able to avoid paying taxes, unless he or she wants to risk going to jail. Tax laws vary from country to country, so I will not cover these in detail here. Be sure to read up on tax laws when investing. Most tax laws can be ‘massaged’ to ensure losses due to this factor are as low as possible.

Inflation

Inflation is the sustained increase in the price of goods and services. This means money will progressively lose value. For instance: if inflation is 2% over one year, it means that a $1,00 apple will cost $1,02 at the end of the year. This factor is also a great reason not to keep too much cash in a sock or under a mattress. It will gradually lose its worth and will not earn any interest to compensate for inflation.

Most central banks strive for an annual inflation of 2%. A modest inflation percentage is a sign of a healthy economy. Investors will have to be wary of inflation. The rate of return has to at least match yearly inflation to make the investments keep their value.

Stress

Of all the mentioned factors this one doesn’t have to be a problem, but is difficult to avoid for many people. Stress will make people buy and sell assets at the worst possible moments. It will make people buy at overly positive, overblown prices and sell at pessimistic, undervalued prices. For every investor, stress can be the single most destructive factor when it comes to returns on investment. Many investors have lost large sums of money due to this factor.

There are many ways to prevent stress from becoming a decisive factor. Behavioral do’s and don’ts will be a future article on this website, but at least try to adhere to these points:

  • Never invest money from a loan
  • Never invest money that is needed for bills or debts
  • Build a defensive portfolio first before making any risky investments
  • Write an investment plan and stick by its rules

Living by these rules will make stress less of a factor than it needs to be. Investing always caries some risk and with it some stress for the investor, but shouldn’t be of influence on earnings.

Conclusion

Always be aware of factors that destroy a great rate of return. The factors mentioned in this article are mostly impossible to avoid, so every investor should at least be aware of these. Take these into consideration when calculating any future return on investment. It will save you from unforeseen surprises.

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