Real Rate of Return

 I had a client recently ask me about something that a broker had said to him about the “average return” on the S&P 500. He said that the S&P 500 had returned an average of (approximately) 10% over the last 20 years, even when you include the terrible results of both the tech crash and the credit crisis. Well, that statement may be factually true, but in reality, it’s misleading. Why? Simple. There is a difference between the average return and the actual return or (some call it the real rate of return), within an account. Let me explain: If you have $1000 in an account and in the first year you lose 50% you now have $500. Now if that account has a 50% gain the second year, it will increase back up to $750. So, at the end of two years, even though the average return is zero percent, the account actually experienced a 25 percent drop. How can this be true? If the average return is zero, how can the ending value be significantly less? Why aren’t these values the same? It’s very simple. The actual return and the average return will never equal one another anytime you have to factor in a negative number. So, since markets do experience negative years, the averaging method just doesn’t work. It will never work. It’s not an accurate picture of how a market or an account has really performed: unless, of course, every year during that period has experienced a positive return. This may help you understand why your 401(k) or brokerage account balance doesn’t necessarily reflect the average gains you’ve seen reported. I shared this with the client. I explained to him that the safe money strategies I talk about, where you never experience a single year with a loss, your average return and actual return will always be the same because this strategy is contractually guaranteed to never have a negative return. No matter how much a stock (or other market) goes down. The worst you can do in any given year is zero. And as I always say, zero is our hero. And when the market rises you grab the gains, and you get a reasonable rate of return. And if you’re looking for a lifetime income, a pension, make an appointment with me and I’ll explain this in more detail and see if Safe Money Strategies are a good fit for you. yoursafemoneyshow.com.