What Is The Required Rate Of Return?

Investing is one of the best ways to make your money grow for you. Whether you are investing in stocks, bonds, or real estate, the main goal is to earn a good return on your money. However, not all investments are the same as some are riskier than others, and hence, the returns can vary. That’s why it is important to know the Required Rate of Return (RRR). In this blog, we will talk about what is the required rate of return, why it matters, how to calculate it, and what factors affect it.

What Is the Required Rate of Return (RRR)?

The required rate of return or RRR is the lowest percentage return an investor needs to make an investment worthwhile. It is based on the risk involved in the investment. For example, if you are thinking of investing in stocks, you would expect a higher return than you would from safer options like government bonds because stocks are riskier.

If explained in simple terms, then the RRR is the minimum return you would want from your investment. It helps you decide if an investment is worth your money and risk.

Why Is the Required Rate of Return Important?

Here are several reasons why the Required Rate of Return is significant to understand:

• It helps you decide if an investment is worth taking. Because if the expected return is below the RRR, it may not be a good idea to invest.
• With the Required Rate of Return, You can compare different investment options to understand which one is better for you.
• The RRR also helps you set clear financial goals as you would know how much return you need to save for retirement or to buy a house.

How to Calculate the Required Rate of Return

There are different ways to calculate the required rate of return. To calculate the RRR for a dividend-paying stock, the formula is:

Required Rate of Return = Dividend / Stock Price + Growth Rate

Here, Dividend is the money you earn from the investment, Stock Price refers to the current price of the investment, and Growth Rate is how fast the investment is expected to grow.

For more complex cases, the Capital Asset Pricing Model (CAPM) is used to calculate the RRR and the formula for this is:

Required Rate of Return = Risk-Free Rate + β ×(Market Return − Risk-Free Rate)

Here:

• Risk-Free Rate is the return on a risk-free investment.
• Market Return is how much return the entire market is expected to provide.
• Beta (β) is a measure of how risky the investment is compared to the market.

Factors Influencing the Required Rate of Return

The most significant factors that affect the required rate of return include:

• Risk: Riskier investments require a higher return to make them attractive to investors.
• Inflation: Investors need returns that are higher than the inflation rate to make sure their money does not lose value over time.
• Time: The longer you plan to keep your investment, the higher the RRR may be as the future market conditions are often uncertain.
• Interest Rates: When interest rates are high, safer investments like bonds give good returns. And this makes investors expect a higher RRR from riskier investments.

Required Rate of Return vs. Expected Rate of Return

Sometimes people confuse the required rate of return (RRR) with the expected rate of return. However, both are different. So, here’s the table for your reference to understand the major differences between them:

Aspect	Required Rate of Return	Expected Rate of Return
Meaning	The minimum return you need to make the investment worthwhile.	The return you think you will actually get on the investment.
Purpose	Helps you decide if the investment is worth the risk.	Shows what you expect to earn from the investment.
Relation	If the expected return is higher than the RRR, then it is a good investment.	If the expected return is lower than the RRR, then the investment may not be worth it.

Also Read : The Power of Compounding Interest Rate in Maximizing Returns

Conclusion

Understanding the Required Rate of Return (RRR) can help you make better investment choices. Now, if you are looking for good returns, check out the 13Karat app. We offer P2P investment options with up to 13% returns per annum and Non-Convertible Debentures (NCDs) with a 16.1% annual return. Download the app and explore these options today to meet your required rate of return!