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 We all save money in plans for our retirement and most of us tie our savings into investments that are market driven.
But are we making the right decisions by looking at market "averages"?
Not necessarily.
We all tend to look at the higher averages of market-driven investments and choose those investments as areas in which we will invest our savings.
But did you know that LOWER averages may actually produce the better outcome when you look at the ACTUAL (vs. average) returns.
Actual return is completely different than average return.
For example:
Let's say that you are investing $5,000 every year into a market-driven investment.
Obviously, you would choose the investment with the best 10 year history average return in order to get the most out of your money.
Which investment would you choose below?
| Investment 1 |
|
Investment 2 |
| Year |
Rate |
|
Year |
Rate |
| 1 |
20% |
|
1 |
25% |
| 2 |
12% |
|
2 |
22% |
| 3 |
-4% |
|
3 |
10% |
| 4 |
34% |
|
4 |
34% |
| 5 |
3% |
|
5 |
-1% |
| 6 |
-11% |
|
6 |
-18% |
| 7 |
20% |
|
7 |
20% |
| 8 |
12% |
|
8 |
16% |
| 9 |
12% |
|
9 |
17% |
| 10 |
22% |
|
10 |
6% |
| Average: |
12% |
|
Average: |
13.1% |
| For illustrative purposes only. Not indicative of individual results. Assumes reinvestment of dividends and no effects of fees and taxes. |
You would choose investment #2 which has an average return of 13.1%, obviously.
But let's plug the numbers in and see what happens.
| Investment 1 |
| Year |
Rate |
Invested |
Acct. Value |
| 1 |
20% |
$5,000 |
$6,000 |
| 2 |
12% |
$5,000 |
$12,320 |
| 3 |
-4% |
$5,000 |
$16,627 |
| 4 |
34% |
$5,000 |
$28,980 |
| 5 |
3% |
$5,000 |
$35,000 |
| 6 |
-11% |
$5,000 |
$35,600 |
| 7 |
20% |
$5,000 |
$48,720 |
| 8 |
12% |
$5,000 |
$60,166 |
| 9 |
12% |
$5,000 |
$72,986 |
| 10 |
22% |
$5,000 |
$95,143 |
| Average: |
12% |
| Actual Paid In: |
$50,000 |
| Actual Return: |
11.43% |
| For illustrative purposes only. Not indicative of individual results. Assumes reinvestment of dividends and no effects of fees and taxes. |
| Investment 2 |
| Year |
Rate |
Invested |
Acct. Value |
| 1 |
25% |
$5,000 |
$6,250 |
| 2 |
22% |
$5,000 |
$13,725 |
| 3 |
10% |
$5,000 |
$20,598 |
| 4 |
34% |
$5,000 |
$34,301 |
| 5 |
-1% |
$5,000 |
$38,908 |
| 6 |
-18% |
$5,000 |
$36,004 |
| 7 |
20% |
$5,000 |
$49,205 |
| 8 |
16% |
$5,000 |
$62,878 |
| 9 |
17% |
$5,000 |
$79,417 |
| 10 |
6% |
$5,000 |
$89,482 |
| Average: |
13.1% |
| Actual Paid In: |
$50,000 |
| Actual Return: |
10.36% |
| For illustrative purposes only. Not indicative of individual results. Assumes reinvestment of dividends and no effects of fees and taxes. |
The investment with higher average return actually produced less money ($89,482) than the investment with the lower average return ($95,143).
Averages can be misleading, and you can't accurately choose an investment based on average return.
So are we making decisions correctly?
Averages Can Be Misleading
Lesson 1
The Choice Dilemma™
Are you making the right investment decisions by looking at market averages?
Lesson 2
The Glass Ceiling™
Find out how average vs. actual return can affect your retirement savings.
Lesson 3
The Retirement Myth™
Are you prepared to live off of only 4% of your retirement savings? You may have to.
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