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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 http://www.mullooly.net, today!
Source: www.isnare.com
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