REAL RATE OF RETURN – SOMETHING YOU NEED TO KNOW
This is very important because it happens a lot. People get their investment statements and look at the average annual rates of return and their balances – and wonder where the money is? Let me explain……..
Let’s say you put $100,000 into a “Growth” Fund .
Over the next 2 years, the magazines say that the “Growth” Fund has an average annual rate of return of 10%. Not bad. So, how much should your account be worth now? It should be worth $122,039. Right!! Wrong!! You have $96,000 – you’ve lost $4,000 – how can that be, it averaged 10%?
Well, here’s how it unfolded……………………..
Let’s say that in the first year, the market tanked, like in 2008/2009, and you lost 40% of your investment, so you ended up with 60,000. That’s bad. However, you decide to stay invested…..
You got lucky, because in year two, the market gains 60%, so you now have 96,000. (60% X 60,000 = 36,000,+ 60,000 = 96,000). But wait, you’re supposed to have $122,039? WHERE IS YOUR MONEY??
The average annual two year return was 10% – the financial magazines say so. (-40% + 60% = 20%, divided by two years = 10%)
So, with a 10% average annual compounded return for two years, you should have $122,039.
But you don’t, why? And remember, you are down $4,000 – why? How can that be?
BECAUSE YOU LOST MONEY SOMEWHERE IN THE GAME.
You NEVER want to lose money. This is important because when you’re calculating your retirement savings need, you have to consider a REALISTIC rate of return between now and retirement on those saved dollars, especially if you are in the market, subject to fluctuation. Wall street needs huge influxes of money to remain in business, that is why you won’t read about this in financial magazines – they need your capital and will use numbers to get it. So rather than be misled by the magazines, understand the real return you as an investor are more likely to earn, and be conservative. Otherwise, it is you who will come up short after it’s too late.