Ever heard of the term “Average Return”? The talking heads on TV and financial planners love this term. How many times have you heard “move your money to me and I can get you a 12% average return”? I wanted to show the difference between an average return vs. an actual return. I’m going to start with this question: if I could get you a 25% average return, would you like that? Let’s assume an initial investment of $100,000 and over a period of four years I am going to show an average rate of return of 25% along with the actual return for the same years:
Here’s the big shock: getting a 25% average return isn’t hard to do, because you can LOSE money and still get a 25% return. I showed a 50% gain in the first year, then a 50% loss, followed by a 150% gain, and finally another 50% loss. The average return is in fact 25% (50-50+150-50 is a 100% total increase divided by 4 years which is 25% per year). The actual return is showing you started with $100,000, and now you only have $93,750.
So next time you get an offer in the mail, see it on TV, or read about it in a magazine doesn’t mean it is of actual benefit to you! A guaranteed 3% or 4% a year sounds way more appealing now, doesn’t it?