Rate of Return Myth — mutual funds

RATE of RETURN MYTH on MUTUAL FUNDS

Here is some infor­ma­tion about rates of return that may inter­est you, espe­cially if you own mutual funds.

After review­ing the illus­tra­tion below, see what is reported to clients with­out dol­lar fig­ures and how the Rate of Return of 25% is allowed to be reported to clients even though they really made a loss.

Year 1 – invest $100,000  if you have $200,000 at end of the year you have a 100% rate of return

Year 2 – begin with $200,000 but end year with $100,000. Neg­a­tive 50% rate of return

Year 3 – begin with $100,000 and end year with $200,000 means once again you have a 100% rate of return

Year 4 – begin with $200,000 and end year with $100,000 means loss of 50%

You began with $100,000, 4 years later you end with $100,000.

Wall Street Waltz will tell you this is a 25% return on your money. How do they come up with that? -

year 1 -   dou­ble your money  + 100%

year 2 -   halve your money     -     50%

year 3 -   dou­ble your money  + 100%

year 4 – halve your money        -    50%

100 – 50 = 50 + 100 = 150 – 50 = 100%

100% divided by 4 years = 25% rate of return

If you are not good at math or don’t under­stand cal­cu­la­tions, you believe what they (the mutual fund man­agers) are telling you instead of see­ing, I started with $100,000 and 4 years later I still have $100,000 so I have made 0% rate of return. So in fact, if you cal­cu­late infla­tion and loss of oppor­tu­nity for the growth of that $100,000 you actu­ally lost money, not gained a 25% return. On top of that you have paid a fee to the mutual fund man­ager so you actu­ally have less than $100,000 now. They get paid whether you take a loss or not. Who is tak­ing all the risk here?

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By using the for­mu­las for cal­cu­lat­ing the aver­age annual rate of return, we get a per­cent­age that mea­sures gains accu­rately over only a short period. Whereas, the geo­met­ric or com­pound rate of return is a bet­ter yard­stick to mea­sure your invest­ment over the long run. The arith­metic mean or aver­age return should be used to cal­cu­late return on invest­ment only in the short-term.

Aver­age annual return (arith­metic mean) = (Rate of Return for Year 1 + Rate of Return for Year 2) / 2 = (100% + (-50%)) / 2 = 25% (Arith­metic return = 25%)
Com­pound return (geo­met­ric mean) = (cap­i­tal / return) ^ (1 / n) – 1 where n = num­ber of years. The for­mula is (100 / 100) ^ .5 – 1 = 0%. (Geo­met­ric return = 0%)

from – http://library.thinkquest.org/3096/42analy2.htm

Mutual fund man­agers report the aver­age annual rate of return (arith­metic) on the invest­ments they man­age. As shown in the above exam­ple, the arith­metic return of the invest­ment is 25%, even though the value of the invest­ment is the same as it was two years ago. Thus, mutual fund reports are some­what deceptive.

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Quite often man­agers will report in per­cent­ages with­out the dol­lar amount as did a man­ager in the scene­rio below. We added in the dol­lar amounts to show you what really hap­pened dur­ing a seven year period between 2000 and 2007.

The mfm who reported this to his clients focused on how great the 83% return was with­out the math show­ing that really 83% meant a 1.92% aver­age return over 7 years.

Most peo­ple think that if they have a loss of 38% that to get back to where they were they only need to have a gain of 38%.

Prob­lem with this is that the loss of 38% was from a high num­ber of $100,000. The new num­ber is now $62,000. So the gain has to be way may than 38% to get back to even, as can be seen on the illus­tra­tion above.

What you should do is actu­ally take your money out when it has dou­bled as then it is in your pocket and now you have really made a 100% rate of return.

There is a bet­ter way. Call me to learn more about it on 845 – 649-7487

I will ask you to sub­mit this form and I will send you a book­let or cd for you to learn more about this sys­tem of bank­ing where instead of divid­ing your money up (in essence uni-tasking your money) into sep­a­rate func­tion­al­i­ties like, some money will be in a retire­ment account 401(k), IRA or Roth IRS. Some money will be in CD earn­ing inter­est. Some money will be in 529 for kids edu­ca­tion. Some money will be in a mutual fund for later on. Some money will be in a sav­ings account. Some money will be invested in stocks or bonds. Some money will pay off debts. etc. etc.

Our sys­tem has your money work­ing for you in all the above areas at the same time with many more advan­tages as well, so pay­ing off your debt can be increas­ing your retire­ment fund cre­at­ing an emer­gency fund and earn­ing you tax advan­taged income all at the same time.

Sound too good to be true, or an impos­si­ble pos­si­bil­ity? Why do you think you think that way? Because every­one has been trained to think about bank­ing and invest­ing in a way the big play­ers want you to think. Instead of doing what the banks say it is time to start doing what the banks do.

Call me and I will be happy to show you how.

Please leave me a com­ment on this post if you would like me to send you a book­let or a cd.