Lessons in computing returns – VII Break even return

Hi there,

In economics and finance, there’s a concept called break even point. Break even point is that point at which you make no profit or no loss. This concept is also applicable while targeting returns on investments. We will call it the ‘break even rate of return’. That is, the minimum rate of return that your investment should generate in order to maintain a no profit-no loss situation.

How to find out the break even target?

The only two factors that eats into your returns are –

  • Inflation  and
  • Taxes.

Inflation, as explained in previous articles, reduces your purchasing power and taxes reduce your disposable income. In other words, your investment should generate a minimum return that will cover the inflation and income tax. So, the key is in finding out the rate of both these factors and generating a return that’s equal to it so that you are position is safe – No profit – No loss.

To do this –

The first step is to find the inflation rate in your country. Inflation rates are published in almost all financial newspapers and web sites.

The second step is to find the income tax rate of the particular investment. In India, only incomes like long term capital gains are taxed at special rates. The rest falls into the general slab system. So find out the slab rate or the special rate you’d be taxed.

Apply the following formula –

  • I / 100 – R

Where –

  • I = The rate of inflation ( you can also take the average rate of inflation)
  • R= the effective personal income tax rate on investments

For example – If the current rate of inflation is 7% per annum and your effective tax rate is 30% , your required return from investments to break even would be –

  • 7 / 100-30
  • = 7/70
  • = 0.10  0r 10%

This means that your investments should earn a minimum of 10% return just to break even and maintain the purchasing power of your money. If you earn less than 10% you are losing money.

That’s about break even point. See you soon.

bye for now !!

You may like these posts:

  1. Lessons in computing returns – III Compounded returns.
  2. Lessons in computing returns – V The Rule of 72
  3. Lessons in computing returns – IV Returns from shares.

1 Response to “Lessons in computing returns – VII Break even return”

Roshni

December 29, 2013 at 7:29 pm

That is a useful number to know. Thanks.

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