The Marginal Rate Of Return – What it is and why it is so important

The marginal rate of return is the return that you get on reinvested earnings. You can think of it as the capital retained in the business or distributed as dividends.

For example, let’s take the example of an individual whose account has $100,000 in it. Assuming that their portfolio returns $3,000 in dividends and $3,000 in retained earnings, they would have a combined return of $6,000. The return that you get on those $6,000 will determine your compounding rate eventually than the original investment.

Therefore, the marginal rate of return is the most important factor.

Over long periods of investment, most of your return comes from the interest that you earn on the interest and not the original coupon rate.

For example, if you invest $100 in a bond that generates 5%, you will have $105 at the end of the year. If you choose not to reinvest this amount, you would have $110 at the end of the second year. This means that your return depreciated to 4.76% in the second year because you had a zero marginal rate of return on the amount that wasn’t invested.

With a marginal rate of return under a compounding scenario, you are reinvesting the interest you earn and thus, make interest on both the original principal and the reinvested interest.