Return on investment

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Under the mattress or invested in real estate, which is the best place for you to put your cash?

If your cash is under your mattress, your return on that investment is zero (in fact some would say that inflation would make this a negative investment).

If you put your cash in the bank you are probably making less than 1 percent, possibly up to 2 percent if you have a long-term CD with a high balance. Cash invested in real estate has the potential to produce much higher returns.

How do you know when an investment is good or not? There are many factors that include tax benefits like deductions and depreciation, but the main message here is to keep it simple. It’s not necessary to get bogged down in fancy spreadsheets or feel the need to memorize the formula for every rate of return calculation in your college finance book.

Keep it simple, how much of your own cash will you spend on the deal and how much cash will the deal deliver to you on a yearly basis?

Here is the simple formula for rate of return: Cash paid to you by the investment divided by the amount of cash invested in the deal. The resulting number is the rate of return. For example, you buy a house for $140,000 with $28,000 of your own cash and you borrow the remaining $112,000 from a bank. (Your cash invested is only $28,000 not $140,000.)

You will rent this house to a tenant and after all of the expenses and loan payments you will have $3,070 of cash left over at the end of the year. So to calculate your return on investment, take $3,070 and divide it by $28,000 which equals 10.9 percent ($3,070 / $28,000 = .109 = 10.9 percent).

Obviously, there are lots of moving parts behind the scenes in this example, but the results paint the picture of a how an actual real estate investment will perform. The moving parts include the expenses involved, the amount of rental income received, the costs of borrowing the money and the condition of the property. These details and others are important and should not be overlooked.

Remember to keep it simple when analyzing an investment. Use the specific knowledge of a CPA, an attorney, a Realtor, a lender and your financial advisor to provide input. Then pull the trigger on the deal that makes sense to you.

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