We know that overall markets are down substantially as we, once again, enter “bear market” territory. As the end of this turbulent year ends, more and more investors will focus on their year-to-date returns (or lack thereof). When faced with substantial losses, investors tend to forget the gift of positive returns we have experienced since the last recession in 2008. Keep in mind that as of this writing (9/21/22), the S&P 500 has had an “average annual return” of 10.62%. It looks good; however, investors must dig a little deeper to understand what average returns actually mean to your account values.
All too often investors use average annual returns to compare investments. Choosing investments based on past performance and average rates of returns can be deceiving. It’s all about the math. Here is an example of two hypothetical portfolios that have been invested in the market for 5 years. Assuming a $100,000 initial investment:
| Trick Portfolio | Treat Portfolio | |||
| End of Year 1 | 10.96% | $110,960 | 3.34% | $103,340 |
| 2 | 28.33% | $142,394 | 6.25% | $109,798 |
| 3 | -37.31% | $ 89,267 | -4.76% | $104,572 |
| 4 | 5.14% | $ 93,855 | 3.35% | $108,075 |
| 5 | 15.71% | $108,600 | 12.32% | $121,390 |
| Average | 4.56% | 4.10% | ||
The numbers speak volumes. The Trick Portfolio had higher returns in 4 out of 5 years, as well as a higher average annual rate of return (4.56% vs. 4.10%). But, at the end of the day, the TREAT portfolio gave you $12,790 more dollars – an increase of 11.77% in just 5 years. Higher average returns do not necessarily translate into more money.
Look at what happens if the Trick and Treat Portfolios both averaged 8% a year. Once again, it is the magic of math that shows the real value of your money. This shows growth of $100,000 over 5 years:
| Trick Portfolio | Treat Portfolio | |||
| End of Year 1 | 14.00% | $114,000 | 12.00% | $112,000 |
| 2 | 18.00% | $134,520 | 10.00% | $123,200 |
| 3 | 12.00% | $150,662 | 7.00% | $131,824 |
| 4 | -26.00% | $111,490 | -6.00% | $123,914 |
| 5 | 22.00% | $136,018 | 17.00% | $144,980 |
| Average | 8.00% | 8.00% | ||
The magic is that you win by not losing! Losing less when the market goes down means having less to make up for. You need to look at year by year returns and not just the averages. Time is money and you can spend a lot of time making up for market losses when you don’t have to. One more point to consider: The market does not, has not and probably never will give you the same fixed percentage return year after year. It just doesn’t work that way. Don’t get tricked with numbers!
Roberta L. Nestor is a financial advisor practicing at 759 Boston Post Road in Milford, CT offering retirement, long-term care, investment, and tax planning services. She offers securities and advisory services as a Registered Representative and Investment Adviser Representative of Commonwealth Financial Network – a member of FINRA/SIPC and a Registered Investment Adviser. Fixed insurance products offered through Nestor Financial Network are separate and unrelated to Commonwealth. Commonwealth Financial Network or Nestor Financial Network does not provide legal or tax advice. You should consult a legal or tax professional regarding your individual situation. Roberta can be reached at Nestor Financial Network, 203-876-8066 or [email protected].