FALLACY of AVERAGE RETURN
We have all seen these types of headlines or even advertisements, "401(k) averaged a 10% return over last 10 years". Or "Stocks returned an average of 8% per year in past 10 years".
Both of these look good compared to the up and down markets of the 2000's, and most people would jump at the chance to invest their money in similar opportunities. While these statement tell the truth, they make you think things that are actually INCORRECT:
There are two types of return in any investment: average return and actual return. The difference between the two is simple....LOSSES. When calculating an average return, gains and losses are equal in weight. In other words, a +50% followed by a -50% leaves an average return of zero. Most people think $100k invested would still equal $100k if you average zero for two years. The interesting part comes when you calculate the actual return. Let’s take the same example and run the numbers to see what really happens. When you take $100k and apply +50%, your account will be worth $150k. Then take the $150k and -50% the next year. You now have only $75k. That is a -25% loss from your original $100k over the two years NOT an average of 0%. Why is this?
To offset this misinterpretation of returns, we put clients into plans that are GUARANTEED to NEVER have a negative year! Since it cannot have a negative year, the AVERAGE RETURN is equal to the ACTUAL RETURN.
Because our plans are indexed, they do four things to provide peace of mind and financial security, they:
- Capture each year of positive gains up to a certain cap
- Eliminate EVERY negative year making your worst possible return in any year 0%
- Guarantee that you CANNOT lose any of your gains in bad years
- Lock in annual gains so you NEVER start with an amount less than the year before