Effective, Required, and Expected Returns: The Tripod for Smart Financial Decisions

Have you ever wondered why some investors always seem to make the right decisions while others get stuck in cycles of regret? The answer may lie in the deep understanding of the three fundamental pillars of any investment: effective return, required return, and expected return.

In this article, we'll explore how understanding these three concepts can completely transform your approach to investing and multiply your wealth in the coming years.

Effective Return: What Actually Stayed In Your Pocket

Effective return is what you actually obtained after making an investment, considering all factors that affect the final result. This is the number that matters, as it represents the money that actually entered your account.

How to calculate your effective return:

To accurately calculate the effective return, you need to consider:

• Gross investment yield

• Taxes paid (income tax, financial transaction taxes)

• Management and custody fees

• Effects of inflation on purchasing power

• Transaction costs (brokerage, spread)

For example, a certificate of deposit that yielded 12% per year may have an effective return of only 8.5% after deducting income tax and considering the period's inflation.

The trap of nominal returns

One of the biggest traps for beginning investors is focusing only on the nominal return (the advertised percentage) without considering all the factors that erode this value.

In 2024, Central Bank data showed that more than 65% of Brazilian investors underestimate the impact of taxes and fees on their investments, believing they obtained returns up to 30% higher than those actually realized.

Required Return: The Minimum Acceptable For Your Goals

The required return represents the minimum rate you need to obtain for an investment to make sense within your financial strategy. This number is your personal "cutoff point" and varies according to:

• Your opportunity cost (what you could earn in other investments)

• Your financial goals and timeframes

• Your risk tolerance

• Your liquidity needs

How to define your required return:

1. Clearly establish your financial goals (retirement, property purchase, emergency fund)

2. Determine the timeframe to achieve each goal

3. Calculate how much you'll need to invest monthly considering different rates of return

4. Assess how much risk you're willing to take to achieve these returns

Generally, the required return for long-term investments should significantly exceed inflation, while for short-term goals, safety and liquidity may be higher priorities than return.

The mistake that can compromise your dreams

Setting an unrealistic required return is a sure path to frustration. Many investors fall into the trap of seeking extraordinary returns in the short term, assuming risks incompatible with their profile or timeframe.

Expected Return: Projecting The Future With Intelligence

The expected return is a well-founded estimate of what you anticipate earning with a particular investment in the future, based on historical data, technical analyses, and market projections.

Factors that influence expected return:

• Historical performance of the asset or asset class

• Current and projected macroeconomic conditions

• Fundamental analysis (in the case of stocks)

• Market and sectoral trends

• Expected risk premium

Techniques to improve your forecasts:

• Use historical averages adjusted to the current scenario

• Consider multiple scenarios (optimistic, realistic, and pessimistic)

• Apply statistical models to reduce biases

• Monitor leading market indicators

A well-calculated expected return is what separates the strategic investor from one who makes decisions based on rumors or "hot tips."

How To Align The Three Returns For Superior Decisions

True mastery in investments comes when you can harmoniously align these three concepts:

1. Compare effective return with required return: Regularly assess whether your current investments are delivering the minimum necessary for your goals.

2. Contrast expected return with required return: Before investing, question whether the realistic projections of the asset meet your minimum acceptable rate.

3. Learn from the difference between effective and expected return: Use this information to calibrate your next projections and reduce errors.

This cycle of constant analysis and adjustment is what differentiates professional investors from amateurs.

The Definitive Solution To Master The Three Returns