How the average annual rate of return can trip you up :: Elliott Wave International

Beware of advertisements that tout the “average” performance of an investment

by Bob Stokes
Updated: 03 April 2017

Would you invest in a fund with a guaranteed three-year average annual rate of return of 50%? The answer “yes” seems obvious. But let’s take a closer look.

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[Editor’s Note: The text version of the story is below.]

In the investment world, things aren’t always what they seem. Here is what I mean:

Let’s say you learned that a fund generated an average three-year annual return of 50%. Plus, there were no fees, commissions, or transaction fees.

Let’s also say that author HG Wells let you use his famous time machine to invest $ 10,000 in this fund. Would you like?

Your answer would probably be something like “Who wouldn’t? “

But, before you get too keen on pulling the levers and pushing the buttons on the time machine, take a look at what our march Elliott wave theorist shared with subscribers:

Looking at the first chart, you would have $ 15,000 after earning 50% in the first year, $ 22,500 after earning 50% in the second year, and $ 33,750 after earning 50% in the third year.

The table on the right shows the actual results of the investors. In the first year, investors lost 90% and had $ 1,000 left in their accounts. At the end of the second year, they lost another 90%. In the third year, they recorded an annual gain of 330%. After three years, they only had a paltry total of $ 430. … The fund had an average annual return of 50%, but investors were 95% less than they had invested in the fund three years earlier.

In other words, the average annual return of the fund doesn’t necessarily tell you what you want to know about the past performance of its investors.

Even using an annual average compound the rate of return doesn’t do much better.

Now consider the DJIA, with another quote from our new Elliott wave theorist:

We analyzed the numbers from the Dow Jones Industrial Average and found that the average annual rate of return for the index from 1901 to 2016 was 7.228%. But this is the benchmark that didn’t work very well in the above scenario. So let’s try the average compound annual rate of return over each 30-year holding period during that period, which is 5.222%. What difference does a two percentage point spread when compounded over a 30-year period? Well, instead of turning a $ 10,000 investment into $ 81,142.09, you would turn a $ 10,000 investment into $ 46,046.49… 43% shortfall of what you paid for. would wait if you had extrapolated the 30-year average annual rate of return. … Once the inflation has been adjusted, the real the yield was only 2.414%.

And, of course, it will be even worse for buy-and-hold investors in the next bear market.

Our posts alert subscribers as to when we expect the next big market turning point, bullish or bearish.

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