While searching for a career I often asked my father for advice. He graduated with a Degree in Accounting from Brigham Young University and later pursued a career in the banking industry in Southern California. He loved the field of accounting because as he would say, “The more honest you are the more accurate the final product will be.”
I guess his words had an impact because I later got an Accounting Degree from BYU and spent several subsequent years in both public and private accounting. For years, I managed the financial affairs of a few companies functioning as a Financial Controller, VP of Finance and CFO. The objective was to produce accurate periodic financial statements so outside readers could make informative decisions regarding the future of the organization.
For many years I traveled constantly visiting over 40 sites in 11 states for a national healthcare company educating and training local General Managers on financial issues. The GM’s were largely clinicians with little or no financial acumen. It was a challenge, but I found success in being honest and making the complex simple.
Nearly 20 years later I serve as a personal CFO for pre-retirees and seniors. Our historic low interest rate environment coupled with a heightened level of market volatility and uncertainty makes effective preparedness even more important today.
Let’s start the preparedness class today by uncovering what most seasoned advisors call the, “The Big Lie.” The Big Lie addresses the concept of stock market averages. The fact is most stock market indexes and mutual fund literature tout performance in terms of average returns. Return statistics on fact sheets and in the media are often displayed as percent averages over one, three and five years as well as over the lifetime of the index or fund.
I can also hear them tout, “The S&P 500 has returned an average of 10.64% over the last 20 years!“ My answer? Hogwash! Oh, the statement may be factually true, but in reality it is very misleading. Referring to this topic a nationally best selling author, Patrick Kelly, in his recent book titled, Stress-Free Retirement offers the following question:
“If a person invests $1,000 into an account, and this account experiences a negative 50% return in year one and a positive 50% return in year two, how much money would be in the account at the end of the second year?”
If we adopt the standard Wall Street line we might conclude that the average return was zero. Do the math! 50% up and 50% down is an average of 0%. If the average return is 0% then shouldn’t the balance of the account be back to its original $1,000? No!
Although the average mathematical return may be 0%, the actual return is a negative 25%! Again, do the math! $1,000 less a first year negative 50% return equals a balance of $500. $500 plus a second year 50% gain yields $750. At the end of two years, even though the average return is 0% the actual experienced return is a negative 25% drop in the account!
Whenever a negative return is experienced, the average and the actual will never be the same. In fact, average will always overstate actual by 15-40%. Since the market always experiences negative returns, actual performance will always be less than average and yet the Wall Street crowd wants you to believe otherwise. That is the Big Lie!
To understand the point further, what was the S & P 500’s average return from 2000 to 2012? The answer is 3.45%. But the actual return, the balance experienced by many in their personal retirement funds, was only 1.61%. Adjusted for inflation the actual return was a negative 0.79% (see www.monkeychimp.com/features/market_cagr.htm). Subtract fees and any applicable taxes and the return was much worse. With such dismal results many have called this period of time, “The Lost Decade.”
Remember my first rule? “Don’t do anything you don’t understand!” Certainly, understanding the difference between average and actual is an important truth. But an even larger truth is the concept of positioning your assets so as to never lose money again, meaning never experience a negative return. Is this possible? Absolutely! Stay tuned while your journey to financial peace continues.