Reasons to NOT be Fooled by Average Rates of Return

The average rate of return does exist, but it is very deceitful. And the very simple way to think about it is to understand why it is not true. Is this very simple example.

Hi, welcome. Today I'm here with my colleague Roman, and we're going to speak about something that, as part of your education, if you're wondering about things like average rate of return, and we wanted to share something with you today about what we know about. About the average rate of return. We just want to help you understand. And I know some of you already have this figured out, but if you haven't, I'm going to encourage you to stay with us till the end, and then you'll have a really good understanding about what's wrong with using the average rate of return. So, Roman, let's get this thing started, and let's just start talking about average rates of return.

Yeah. So the average rate of return is a term that is widely used by financial advisors where they present an investment opportunity. They say, you know what, look at this fund or whatever it is, this stock or something else that has this particular rate return. And what they look at is an average rate return, meaning that they take all the returns for all the years. For example, for last 10, 15, 20, 50 years, maybe five years, they take the returns, it may be positive, maybe negative, and they just add them up and they just divide by the number of the years. Is that accurate? Not usually. So what happens with the average rate of return is it appears way better than it is in life. So we just wanted to kind of talk about this myth. If we should trust the average rate of return or what should we do to stay away from it? And what is the truth? How should we go about finding an actual rate of return?

Yeah, that's a really good point, Roman. So that's all we're going to do. You know, when you think about if you put your money somewhere and you get a return that year, well, that's the change in money. It can either go up or it can go down. So if you invested it somewhere where the average rate of return for that year was less than 1, well, the money you put in will be less. And if it was more than one, money you put in will be more. And so it works on a yearly basis. You can easily calculate if the rate of return was 10%, well, the value of your money would have went up 10% in that year. Year. But if rate of return the next year is different than 10%, well, you know, if you just take those two numbers, add them together and divide them by two, you're going to get the average rate of return. You may not realize is that average rate of return doesn't actually help you understand how many dollars you have at the end of the two years or end of the five years or end of the six years or end of the 10 years, whatever it is. And that's the problem with average rates of return. They don't tell you what happened to your money. And Roman and I, we're going to say follow your money. Like you want to know what would happen, you know, and again, I digress, Roman, but I go back to. Because I lived through 2008 and I seen a huge correction and also talked to people that took 10 years to actually get back to par. And I'm talking about where they had the same amount of money that they had back before the correction in 2008. So 10 years of time went by to get them back to just where they started, not talking about any return or greater number, just back to where they were. That's the key thing we wanted you to understand today is, hey, a rate of return doesn't tell the story.

Yeah, the average rate of return does exist, but it is very deceitful. And the very simple way to think about it is to understand why it is not true. Is this very simple example. For example, let's say we have a negative return in the first year of 10% down, and then we have a positive return of 10%, 10% up. Right. On numbers. If you do minus 10% and then plus 10%, that's zero, divided by two years, that's zero. So you should be neutral. And so then what happens in real life? Let's say we have like $10,000 to invest. So what happens? Can you walk us through that example?

So that's a great one. So if you lost 10% in the first year, so 10,000 times 10% is a thousand, and you lose that, but now you got $9,000.

Yes.

And. And then the second year you go up 10%. So you take 9,000 times 10%, that's $900. So after two years, you have $9,900. So actually $100 less than you started with. But like you said, Roman, if you did the average, you would have had. You'd have had $10,000 at the end of the second year. But by rights, you don't have 10,000. You've got now 9,900.

Yeah. So on paper, it looks good, or maybe at least neutral, but in real life, you Got factoring some fees that you may incur.

Right.

This is what we wanted to share today with the real numbers with real index that we wanted to discuss today. And that is S&P 500 returns from year 2000 to year 2010. So that's 11 years from year 2000 to year 2010. And what I'm going to do is I'm going to share my screen and we will talk about the average rate of return for S&P 500, and we're going to talk about what it looks like on paper and in reality. Right.

We just picked those 11 years. Now, we could have picked a different 11 years and the numbers would be different, but we thought, well, this is a great 11 years just to use to help people understand. And so we went to the S&P 500. We looked at the annual rate of return for that year, and that's the numbers that we plugged into this simple spreadsheet.

Yep. So let's look at $10,000 principal investment that an investor has at the beginning. Let's say January 1st, year 2000.

Right.

Right. So in the first year, there was a loss of 10.1%. In the second year, year 2001, there was a loss of 13%, and so on, so forth. We have so many negatives. We have three negatives in a row, then we have some positives, and then we have a negative in 2008, obviously, because we had a market crash in 2008. And then markets, you know, recovered and showed some profit, some positive returns. So if you just simply add all those up and divide by 11 years, then the average rate of return is 0.62%. Is that true? Maybe. We don't know. Let's look at that. Let's look at real numbers, and let's look at what would the real dollars look at? The end of year one. End of year one, there is a loss of 10.1%. So $10,000 principal goes down to 8,990. Right. Next year goes down to 7,821. And then so on, so forth. At the end of the 11th year, at the end of 2010, the principal is actually $8,564. So we started at $10,000 principal in investment, and we ended up actually incurring some loss. As you see, the loss is $1436. So how do we go about calculating the actual return?

Yeah, so it's pretty simple math. Right. So all you do is you take the first year, calculate it by rate of return, and then Use the amount now. So, like, in the first year, you have $8,990, and the next year, you calculate it by the next year's rate of return. And you do this that year over year. And that will just. That's where you're. If you're following your money, that is exactly what would have happened to your 10,000 if you happen to start putting it in. In year 2000 and you kept it there just in an S&P 500 rate of return average over those 11 years. After 11 years, like Roman did a good job of explaining, you would have $8,564. So you lost 14 $36 over that time of 11 years. So all you want to do is you can just calculate that out. So it's actually a 1.31% loss per year is what it worked out to be. And we could have picked a different period of time, and we could have shown that the numbers went up because that happened. It could have taken another 11 years, and the numbers would have gone up. But we're using this as a. As a teaching tool to help you understand that you want to always follow your money. You want to, you know, average rates, returns are just a number. What you want to focus on is what happened to your money? How much did I actually get? And like, you did such a great job of speaking to before, Roman, and everybody should know this is there's no factor of fees in here. So if you're in the market, and I've been in the market, so I know this, there's always costs a to buy stock, get into markets, sell stock. There's, you know, those things all are factored in there.

Right?

So there's going to be other costs. We didn't even calculate those. We just trying to help people understand how average rates of return don't tell the true story. So I know. Next, Roman, you want to talk about, well, if the average rate of return was actually 0.62%, what would that look like if you were actually able to get 0.62% average rate of return every year versus what the actual outcome was? And that's what you know. I know you're going to go into explaining to people if they use that 0.62%, what would have actually been the outcome after those 11 years? So I'll let you go through that.

Thank you, Dan. You truly said that we didn't factor any fees. So just to show the importance of understanding the average rate of return versus actual analyzed rate of return, we're not talking about any fees. So in fact, in reality this number would have been lower because of the fees, because the portfolio managers and other professionals, they actually make living off of our investments, right? So they deduct fees regardless of, of if there's a loss, of if there's a profit. So let's just put fees away for now, but really focus on what is going on with the balance. If there's only investment and no fees, just assuming no fees. Right? So in the first year, let's say we take this principle and if this average rate of return was actually true, then the balance should have been on average going up and compounding at about 0.62% every year. So on average, if you compound and do this for the time span of 11 years, this is what's going to happen with the balance. So at the end of the year 11, the balance should have been about $10,701.41, bringing us bringing the investor a profit of $701.41 expected profit. Again, no fees are assumed in this example. Just showing what the balance should look like at the end of 11th year. You can compare that the differ more than $2,000. Right. So in this example, in the real case, we got a loss of 1436 and the expected profit is actually $701. And the difference is almost like $2100. It's a huge difference. Right. So what we wanted to share, what we wanted to emphasize is always look at actual return, annualized return, not the average one. Don't be fooled by the professionals who show you numbers based on average returns.

Average rate of return doesn't tell you what's actually happening. So follow the actual annualized rate of return. And that's, you know these numbers that we displayed in column F here, that is what you need to focus on and understand. So that was a great example, Roman, of helping people understand why it's not a good rule to just use average rates of return. Always use the actual annualized rate of return and you'll get a better result and it'll tell you what you really want to know and need to know because it's your money. So both Roman and I are infinite banking practitioners and what we'd encourage you to do, if you don't know what that is all about, is to go to watchibc.com and that's a 90 minute video that will just help you understand what is the infinite banking concept all about. And you know just why it may be something that you could use in your life. And the other thing that we really wanted to encourage you with today was to go to watch a series of videos that we have on our YouTube channel here. And that series of videos is simply titled Infinite banking with Nelson Nash. Now here's something I can tell you. Nelson Nash was the author and he's the one that, you know, come up with the concept. And so we've got a series of 30 videos available on our YouTube channel. And that's the banker's vault that you can go and watch with the man like Nelson himself speaking. And it's well worth your time. And we're just going to encourage you to go there and take in those videos because Roman and I have, you know, been taught through the Nelson National Institute about infinite banking and how to teach people, help people understand that concept. But there's no better speak live a few times than Nelson himself. So those are great videos that you can get access to right here in our channel. Roman.

Yeah, I also wanted to emphasize the importance of reading this book because you know, this is what we do. Becoming your own banker by R. Nelson Nash. If you haven't read this book yet, make sure that you get a copy and you read this book book and learn how you can also become your own banker without market risk, without putting your money in a prison. But still you can start your own banking system and have access to liquid capital if you need to.

Key part about becoming your own banker, putting it in practice is you're going to get a increase in value every year and you'll learn you get to enjoy uncompounding of your values every year if you practice this concept. So unlike the temperamental markets that can go up and down, it teaches you to how you can achieve certainty. Something that over time it's consistent, it goes up, it goes up, it goes up, can't go down. And that's a guarantee that's in, you know, the contracts that we use to practice the infinite banking concept. You work with the contract, it happens to be a dividend paying whole life insurance policy because it's the best tool that we found, Nelson found to do this with. And the thing I love about it, Roman, is that the value, my values can't go down. And when you talk about that book, hey, there's been over 500,000 copies of that book sold. It's a self published book. Well, why, why has so many copies of that book been sold?

Because people learn how to be independent from the banks, secede from this traditional banking and compound your capital uninterruptedly. So compounding is a eighth wonder of the world, but the nint wonder of the world is uninterrupted compounding. This is what you want to do. You never want to interrupt your compounding. You never want to stop growing your wealth, but you want to put your money in a system that you own and control. And you compound. And you at the same time, you have access to liquid cash if you need to.

That's great. And the other thing I always tell people is it's because it works. We're going to tell you watch some more videos on our channel, especially if you can get to that now series. That's a great amount of content to take in. And until we get a chance to speak again, we just wish you all the best.