One of the old sayings that continues to ring true is that the price you pay dictates your return. The lower price you pay, the potential for a higher return when all else is equal. For example, if we had a security that we expect to be worth $100,000 in five years, our returns would look vastly different depending on whether we paid $25,000 or $90,000. Had we invested $25,000 initially our cumulative annual growth rate (CAGR) over the five years would have been 31.95%, while investing $90,000 would have yielded a CAGR of 2.13%.
Dimensional Fund Advisors put together a number of studies on Price and Returns and the most recent one laid this out graphically.
Dimensional Fund Advisors. Cumulative Average Growth Rate is calculated as Terminal Value/Beginning Value raised to 1/N, where N is the number of compounding periods.
This doesn’t mean go out and look for the lowest priced securities, be they ETFs, mutual funds or individual equities, with the assumption that everything grows to the moon and those with the lowest price should offer the highest returns. Some of the cheapest securities may be cheap for a reason.
Security prices rapidly incorporate new information, positive and negative, and therefore should be monitored in order to gauge expected return.
