BEWARE: How Your Portfolio Can Lose Money But Still Be Shown As A Gain
Did you know that your investments could be losing money, even if it has an average annual gain? Here’s how…
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Manipulating Average Returns
The way portfolio managers and custodians of retirement accounts can lose you money while still advertising a gain is by manipulating the average of returns. They do this without you realizing how percentages apply to losses. If you invest $100,000 into a volatile investment portfolio, you may lose some years, but gain in others.
You could lose 15% one year, but gain 15% the next. By the standard of averages, your average return is 0%. However, your actual dollars are much different. The first year, you lose 15% of $100,000, meaning you have $85,000 left. The second year, you gain 15%, but of $85,000, not of your initial $100,000 investment. This means your actual cash in the investment is $97,750. An actual loss even though your average annual gain wasn’t negative.
This is a legal and factually correct way to advertise returns, but in reality, it can lead to losses. Take the example of the S&P 500 from 2000 to 2010, a period where markets hurt and so did investors. The average rate of return was 0.61%, which is a terrible return, but wouldn’t look like a loss, but when you dive into the numbers, you'll realize that if you invested $100,000 during this time period, instead of it growing at a consistent 0.61% to $106,000, you would actually be left with $76,000. That's a 25% true loss hidden as a 0.61% return.
Depending on when you start and stop a case study, you can almost always make an investment look bad or good. But as an investor, you should understand that averages over the long run don't always equal gains or even positive returns in some cases.