Do you live in a world of “average rates of return”? Or, do you live in the real world with sequential rates of return like the rest of us? Between average rates of return and sequential rates of return, which rate of return is real? Financial advisors, financial representatives, bankers, trust officers, 401Ks, etc. all report to you what the average rate of return has been for you over an extended period of time, but is that misleading?
I am not going to be talking about fees today. I’m not going to be talking about expenses. I’m just going to be looking at the simple math of average rates of return vs. sequential rates of return. Let’s see what the real-world examples are and how it actually plays out.
I have put up a 10-year period of time showing $100,000 as my beginning balance and an average annual rate of return of 9.43% every year. If I begin at $100,000, at the end of 10 years of receiving a 9.43% rate of return, I should have $246,243.
Let’s take a look at another example that shows the markets under a normal situation. I’m going to use true market history from 2005 to 2014 that shows an average rate of return of 9.43% for those invested in the S&P 500 with dividends being reinvested. This is hypothetically if you could buy without any expenses, which none of us can buy into the market without some sort of fees, costs, or commissions. I took those actual market historical rates and put them on our original chart. The average rate of return is still 9.43%, but the yearly values reflect what truly happened sequentially.
The end value in this example is $209,057 dollars. Wait a minute. That doesn’t seem right! In our first example, with an average rate of return of 9.43%, I should have received $246,243. That first example didn’t reflect what happened in the real world though. That’s a difference of $37,000 over a 10-year period of time!
This is the difference between an average rate of return and a sequential rate of return. Which world do you live in: an average rate of return or a sequential rate of return? This is a very important question to ask yourself and your investment advisers that you are meeting with. What rates of return do they use, and how is it affecting your life? If this has been a brand-new concept to you, perhaps it’s time to schedule your Financialoscopy®.
