Rule 28: Calculate the Net Return

I realize that when I ask you to “calculate the net return,” it sounds really boring. It’s not.

This rule is about making decisions. It’s deciding if and when you’re going to buy that house or take that vacation, when you can afford to retire, how much money you can leave to your kids or donate to charity, what kind of car you’re going to drive.

You can answer these questions if you calculate the net return.

‘Net’ the final amount of profit or loss after all expenses are included. But do you remember to factor in the costs, expenses, charges, and tax before deciding whether to make a purchase or an investment? Base your decisions on the real net return and don’t fall into the trap of just seeing the headline figure.

Here’s an example. Suppose you buy a property to rent it out. If it costs you, say, $100,000 and you lease it out at $10,000 a year, you might think that looks pretty good. That’s a 10% return. But hang on. What have you got to factor in before you make your decision? Well, there’s the cost of the mortgage, the insurance, leasing agent’s fees, and periods when the property is empty between tenants. Oh, don’t forget the tax on the rental income.

Here’s another. Let’s say you buy a boat. Your cost isn’t just the boat. There are phantom costs associated with it. There are the upfront purchase costs, taxes, loan interest, and annual maintenance. Don’t forget the trailer, boat insurance, boat storage, marina fees, boat equipment, safety courses, boating licenses, etc. It’s not just the boat.

See? You’ve got to calculate the net return before you can decide if this is a good move for you. Obviously there’s also the potential capital growth in a property to consider, but that’s not guaranteed except perhaps over the very long term. Certainly if you need to sell the property in five or even ten years time, you can’t assume significant growth, and the value may even have dropped.

So, do your math. It’s not complicated, but it requires you to think it through and make sure you haven’t forgotten anything, especially the tax.