Did you read When Returns Lie? This will be a continued discussion so make sure you read where it started and check the comments. Now I want to thank Paul Escobar for pointing out that there are more accurate ways to measure the returns on your investments (not for laying into me while doing it). I wanted to show you how some financial people talk about rates of returns and how they can be very deceiving. I’ve seen a recent push by financial people to talk about how great market is and paint a positive outlook on the market in order to get people to invest more with them. I’m not commenting on the market here I’m instead making you aware of the tactice people are using.
What can you do about it?
The fist thing to do is the take a lesson from Paul. Make sure the financial professional that you are talking with or working with is using the geometric or compound average rate of return. I think All Returns Are Not Created Equal from Investopedia does a great job of explaining the differences between these two calculation techniques. Unfortunately, if you look around the internet you will learn that mutual funds sometimes advertise the arithmetic mean or simple average. When you have positive returns these numbers are very closely related. When you throw in a big down year, such as 2008, it throws numbers wildly off as represented in my previous post.
There is was a question posted on LinkedIn for me titled Interested in your take on this. See how people responded. Most acted as if they know about the way in which returns are falsely advertised. I hope they are sharing this with their friends and in some cases their clients. I also recommend Average Long Term Returns vs. Compound Annual Growth Rate and Mutual Fund Return Lies: Average Annual Return vs Compound Annual Growth Rate which both help support my point.
Did you learn something new? How does your adviser show you rates of return? I guess I hope that you will realize that a rate of return that is sold to you or shown to you during some sales presentation might very well be nothing but a number and have no real meaning behind it. Or maybe worse yet, it’s that a trusted adviser might be using these false methods to predict your future. Am I naive to think that people will learn from this post?
Related posts:
{ 2 comments… read them below or add one }
That’s a good post, especially for funds or investments that are very volatile.
Looks to me like for a normal retirement portfolio at 10-12% volatility, the difference between arithmetic and geometric returns would be about 50-60bps.
For the S&P, the difference would be about 1.5%, and for emerging markets it’s closer to 3%.
P.S. – Your friend Paul could be a bit gentler in his tone.
Thank you for your comment. I have to give Paul credit he came out with what I was sort of looking for. I wanted someone to say I was wrong because there is a better way to do it. Unfortunately, I think I showed that there’s a lot of people out there that don’t realize it and believe some of the misinformation. Have a great day.