The majority of hard-working Americans believe certain financial myths. To attempt to correct these myths is similar to telling a mother her baby is ugly. The “conditioning” that has been experienced is frustrating, to say the least, but understandable…especially when you realize who has been doing the conditioning.
For example: why are we constantly directed to focus on the average rate-of-return? From investment brokers, financial planners, “experts”, to our financial statements, all of these reference “the average”. If we truly add up the numbers for each year and divide by the total number of years, does our statement really reflect a return that is the same as the average?
YOU CAN’T SPEND “AVERAGE”
There’s a popular “expert” (he’s also a radio host, TV personality, and a creator of a curriculum that dominates financial classes in churches) who always quotes the average return. In a recent article he took the inputs of the S&P 500 from 1990 to 2009 to get a 10% average. Mathematically he’s right. He then claimed that your investments would have performed at 10% for each year during that time. Mathematically he’s wrong. Again, this is like telling a mother her baby is ugly. It’s hard for most people to understand that the “average” is just a number but the “actual” return is what their statement reflects.
Let’s use the above example. Between 1990 – 1999 the S&P 500 averaged 19% and between 2000 – 2009 it averaged 1%. Add the decades together for a total of 20% and divide by two to get 10%…this is exactly what this supposed “expert” did to prove his point about how well you will do if you just “stay in the game”. Now, let’s take $100,000 invested from 1990 to 2009 with an actual 10% rate of return (meaning you actually get a 10% return each and every year). How much do you have? You’d have a balance of $672,250. Nice job.
Now, what would have happened if you actually rode the roller-coaster, took the losses and took the gains during that exact same time period? Your balance would actually be $473,000 which represents an 8.08% rate-of-return (this assumes no fees and no taxation of course). You see, you don’t earn the average. Look at this example: Year 1 = 100% gain. Year 2 = 50% loss. Year 3 = 100% gain. Year 4 = 50% loss. What’s the average? 25% (100-50+100-50 / 4). If I follow the logic from our expert and I invest $100 for four years at an average of 25% then my balance should be $244. But, if my money was ACTUALLY in the market then Year 1 my $100 becomes $200 because of the 100% gain. Year 2 I take a 50% loss so I’m back to $100. Year 3 I again enjoy a 100% gain and have $200. Year 4 I take another 50% loss to get me back to $100…right where I started.
The above mentioned “expert” could look me in the eye and say “look, you averaged 25%” and he’d be right but yet I earned NOTHING. Even worse than that but I probably had to pay taxes on my gains for Year 1 and Year 3 (since he only recommends mutual funds)…all this hurts me even more. My money didn’t even keep up with inflation but in fact it lost! Would you be surprised to know that if you take a very conservative tax calculation and only 1.5% in fees that your actual rate-of-return would equal 4.72%? It’s true. Your statement wouldn’t show $672,250 at the end of year 20 but instead $251,590.
YOUR BABY IS UGLY
Folks, you have to ask yourself two questions:
- Who’s teaching you to focus on the average rate-of -return?
- Do you truly believe that they have your best interests at heart?
Seriously. If you say “no” then are you willing to be told your baby is ugly? Would you maybe reconsider a rate of 6% with no fees and taxation? Which would you rather have, the $100 after four years or $126? It doesn’t take much once you understand the impacts of losses, fees, taxation, and most important, the lost opportunity costs of all three.
Ordinary people CAN create extraordinary wealth. It’s not just a game for those “with the money”. You just have to learn how to get control of your money and we can show you how.
Kelly O’Connor – email@example.com