Lie #1: “Look at the great average return of this fund, stock, ETF, or portfolio!”
Average returns are sleight of hand. On the surface, they are basically “fake math.” For example, let’s say you invest $100 into a fund and, as luck would have it, a recession hits and you lose half your money. You just experienced a -50% return. However, taxes are cut, interest rates are lowered, and the market snaps back +50% the next year. Your account now sits at $75. Technically, it’s honest to say you’ve averaged a 0% return because -50% + 50% = 0%. But even though it’s technically true, touting a 0% return over those two years is incredibly misleading because the real rate of return on your dollars is a -25%. Assuming you’re a principled investor, you stay invested another year and your portfolio comes roaring back another +25%. Now you have $93.75 in your account. You’re still well below your original principal, but the advisor (or fund manager, etc.) can legally tell their next prospect “Our portfolios have returned an average of 8.3% over the last three years.” Here’s how they’re calculating the fake math: -50% + 50% +25% = +25% net return. Divide 25% by three years and you have an 8.3% average return.
Read the full article on Forbes.