A required rate of return is the minimum level of profit that an investor will accept. For some investors, the required return is set based on the returns they need to achieve to attain certain financial goals. For others, the required return is different for each investment, based on its risk.
Targeting Financial Goals
If you're figuring the return you need to achieve to reach a financial goal, such as a target amount for retirement, your required return is the rate you need your investments to grow at as a whole to reach that goal. For example, if you've saved a lot when you're young, you might not need a very high required return for your retirement savings. That means you can put your money in less risky investments that have a lower rate of return.
Accounting for Risk
Investors often have a higher required return for more risky investments. For example, if a startup company has a greater risk of its business model failing, investors will demand a greater expected return to compensate for taking on the increased risk of losing money. Alternatively, a company with a proven business model may be attractive even with lower predicted returns because there is less risk of the investment turning sour.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."