Absolute Value vs Relative Value

Wow! Without realizing it, it has been 1.5 years since Aunty Scroogey’s first post in this blog as a guest columnist. The Aunty hopes that all her readers out there have picked up a thing or two about financial matters from her blog posts. But remember, doing homework on your own is important if you want to make faster progress in your financial education.

Given that it has been 1.5 years of basic training, it is about time that you should start to venture into something more intermediate, starting this year. For a start, as serious investors, you should be looking at relative values instead of absolute values like most laymen do. If you’ve been following my posts since the early days, you would have an idea of relativity in the context of expenses versus spending power. Looking at relative returns as an investor is somewhat similar.

Let me give you an example. Mr & Mrs FPN sold their property, which they bought for $2 million 5 years ago, for $2.3 million. On the other hand, Mr & Mrs SQW sold theirs for $750,000. They had bought the property for $500,000 5 years ago as well. To make matters simple in this illustration, let’s ignore transaction costs. So which couple had a better return? Most laymen will say its Mr & Mrs FPN, as they earned a profit of $300,000 while Mr & Mrs SQW’s profit was only $250,000. Well, these are absolute values. If you are serious about being a serious investor, this is NOT the way you should be assessing your investments.

Assuming both couples made a downpayment of 20% on their respective properties, it worked out to $400,000 for the FPN couple and $100,000 for the SQW couple. Assuming uniform funding costs for both couples, it means that Mr & Mrs FPN registered 75% return on their capital. What about Mr & Mrs SQW? Well, the returns worked out to 2.5 times their capital or a whopping 250%!!! So, who did you think have a better return from an investor’s perspective?

Just as whether an item is cheap or not is relative to earning power of the person in question, whether you have good returns is relative to the capital that you have to put up to acquire the investment. If you’ve always been looking at absolute values to judge your investments, it is perhaps time to have a change of mindset. What better time to do so than to start doing it in the new year?

Homework: Google and understand the meaning of CAGR, which stands for compound annual growth rate. When and how do you use this ratio?

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I hail from a little red dot on the South China Sea call Singapore. Am an extroverted introvert and notorious for nothing and everything. I often suffer from logorrhea so please do not take what I say too seriously.

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