The financial services industry is huge and they have a multi-billion-dollar marketing machine behind them. I often find people accept what they are being told instead of trying to dig a little deeper and find out what is really going on behind the numbers and behind what is being said.
I want to expose one of the lies that most people are being told around average return.
Have you ever talked to a financial advisor and they told you that the stock market gets an average return of 8%?
Do you ever feel after a few years of investing with that advisor or in the stock market, you feel like you have barely got ahead?
Let’s say you invest it $100 in a mutual fund after five years you would expect a return of between $140 and $150 as an 8% average return.
Let’s use the following sequence as an example:
Year 1 $100 with a 10% ($10) increase that is $110.
Year 2 $110 with 50% (-$55)decrease with a stock market correction that is $55.
Year 3 $55 with a 50% (+$27.50) increase with a quick recovery that is $82.50.
Year 4 $82.50 with a 20% (+$16.50) increase with the continued good market $99.
Year 5 $99 with a 10% (+9.90) increase with the continued good market gives you $108.90
Average 5 Year Return = 8%
That’s right you end up with an average return of 8%,
but you only ended up with $8.90 more than when you started.
Most people try to calculate returns based on what has happened in the past, the problem is that the future is unknown. And of course, every mutual fund prospectus states that past results don’t guarantee future preformance.
If you start investing in a bad year, it could take a decade for your $100 to recover, even at an 8% average return.
In fact, using this example, if you put your money in a high interest (2%) savings account you would have ended up with a higher cash on cash return and it would have been more secure.
Don’t listen to those people who are telling you to create a pile of money for retirement in 50 years, create streams of money and retire when you want to.
Quentin D’Souza is the Chief Education Officer of the Durham Real Estate Investor Club. Author of The Property Management Toolbox: A How-To Guide for Ontario Real Estate Investors and Landlords and The Ultimate Wealth Strategy: Your Complete Guide to Buying, Fixing, Refinancing, and Renting Real Estate.