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You Can’t Eat Average Returns!
By: Thomas Mullooly
It seems almost once a week I hear some buffoon stating that “the average return
for stocks over the last (fill in the blank) years has been 10%.”
Listen, I don’t care about “average returns.” And neither should you. I’ll
explain why through a simple math problem. Add up these positive and negative
numbers: -25, +30, +10.
I get +15 as my total answer. The average of the three numbers is +5. Suppose
you’re looking at your investments and you learn that these three numbers are
what the stock market returned the past three years (it didn’t).
You calculate that the total return should have been 15% for the last three
years and +5% is the average annual return the past three years.
Or was it?
Now, let’s apply these numbers to your account. Say you started with $100,000
three years ago.
Let’s do the math:
Year One you lose 25%, you’re down to $75,000.
Year Two you make back 30%, now you’re at $97,500. Still underwater!
Year Three you make another 10%, now you stand at $107,250. You made $7250 in
three years.
This actually works out to be an “average” of $2416 per year, or 2.4%...not the
5% advertised.
Maybe the order you earned these returns will matter, you say? OK, try this:
Year One, you make 30%, and $100,000 has grown to $130,000. Great!
Year Two you lose 25% and now $130,000 drops to $97500. Uh-oh.
Year three you make back 10% and you are back at $107250.
Wait, let’s mix the numbers again for one more time!
Year one you make 30% and your $100,000 grows to $130,000.
Year Two you make another 10% and now the account is up to $143,000. Cool.
Year three you give back 25%. The account is now worth $107,250. Bad.
Beware the man touting average returns!
Repeat after me: you can’t eat “average returns.” Average returns do NOT
translate into actual dollars in your pocket! Don’t believe average numbers!
This is important: you’re going to NEED this money someday to pay for college
expenses, pay for retirement, pay for medical costs, pay for living expenses and
on and on. “Average” returns will be of no use to you when you really NEED the
money.
We need to do everything in our power to avoid losses. As you can see from the
examples above, negative numbers (losses) will destroy more portfolios than most
other mistakes investors can make (and they can make some whoppers!). That one
year loss of 25% above is a killer, no matter what year it appears in! You can
beat the market simply by avoiding the big down years, or minimizing losses in
bad years.
That’s EXACTLY why we use a tactical approach of measuring supply and demand
when examining your investments. It’s not just important, it is CRITICAL that
we’re aware (in real time) what sectors of the market are in demand (where their
prices rise) and which areas of the market are experiencing greater supply
(where prices fall). Simply staying far away from weak sectors can drastically
improve the outlook of your portfolio.
Buy a Photo Album!
We’re also not helping ourselves at all when we make mistakes like hanging onto
losing investments (only because someday it MAY come back). Keeping certain
stocks for sentimental reasons is another bad idea. Photo albums are for
sentimental keepsakes!
Suppose, instead, that the -25% return (loss) for one year was actually a flat
year? Where there was no gain or loss at all. How do the numbers shape up now?
Pretty well! But let’s be realistic, suppose the year that the market lost 25%
...you only lost 10%. The account would look much better than most others in the
market at that time!
Minimizing losses will improve the overall picture each month on your
statements. Simply waiting for an investment to recover is a bad strategy.
Eliminating losing investments from your account will make your statements look
better. And you’ll free up cash for other areas of the market that are working.
Or when times get rough and we need to be defensive, eliminating a loser is a
great way to raise cash.
About the Author:
Thomas Mullooly, President of Mullooly Asset Management, works one on one with
individuals so they can regain control of their investments. Tom's popular email
alerts help folks to reduce the risks in their portfolios. To learn how to stop
making simple investing mistakes and to sign up for Tom's email alerts, visit
www.mullooly.net, today!
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