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Myth #2 - Average Rate of Return Matters?


I hear many speak about the average rate of return for some investment in the market. Often this is misleading to people who think when you put money in the market then that is what you can expect. Truthfully what matters is the actual rate of return. Here is an example. Im using round numbers to keep it simple.


You invest $100,000 into the market

The first year you make a 100% gain so now you have $200,000

The second year you have a 50% loss and you now have $100,000

The Third Year you have again have a 100% gain and again have $200,000

The Fourth Year you have a loss of 50% again and are back at $100,000


You started with $100,000 and four years later you have $100,000


What was your average rate of return? 25% and yet your actual rate of return is 0%.


You Ended up with no gain at all. We didn't figure in any fees or taxes either. The more volatile the swings the more the average rate of return won't matter. So next time you hear "the S&P has averaged this or that" just know there is more to the story than that. It doesn't make it good or bad but it does help us look at it more clearly so we can consider the value and risk properly.

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