I saw this question come up in a Dateline NBC piece on retirement. So here goes: You have an investment that delivers a 7% return each year. However, you are charged a 2% management fee. What is the real rate of return on your money?
Try to figure it out yourself then scroll down for the answer…
The answer is NOT 5%. Close, but not exactly.
It’s 4.86%.
Think about it like this:
You deposit $100 in the investment.
At the end of one year, you have a 7% return. That’s $7. Now your account balance is $107.00.
But now those investment managers take their 2% from the $107.00, which comes out to be $2.14.
That leaves you with $104.86 or a 4.86% return for the year.
A more straightforward solution is: Rate of Return = (1+0.07)(1-.02)-1 = 0.0486 = 4.86%
Please comment below, and let me know if you got it or if it was too hard, too easy, etc.