"Knowing Your True Numbers: Don't Be Deceived"

In the world of investments, understanding your true numbers is crucial for making informed financial decisions. As an investor, it's essential to look beyond the surface and understand how returns are calculated and presented. Today, we'll delve into the often-misunderstood concept of the 3-year average return, using a real-world example to highlight why knowing your true numbers is vital.

The 3-Year Average Return: A Closer Look

Let's start with an example. Imagine you begin with an investment of $100,000. Over three years, your account experiences the following annual returns:

• Year 1: -50%
• Year 2: +75%
• Year 3: 0%

At first glance, the brokerage firm may present this as an 8.3% average annual return. But let's break down what this really means.

The Brokerage Firm's Calculation

Brokerage firms often use a simplified formula to calculate the average annual return. They sum up the returns and divide by the number of years. Here's how they might present it:

• Year 1: -50% (resulting in $50,000)
• Year 2: +75% (resulting in $87,500)
• Year 3: 0% (resulting in $87,500)

Adding these returns: -50% + 75% + 0% = 25%

Dividing by 3 years: 25% / 3 = 8.3% average annual return

This presentation can be misleading. While it appears that your investment has grown by an average of 8.3% per year, the reality is quite different.

The True Process: Understanding Real Numbers

Now, let's reveal the true numbers:

• Starting with $100,000, a 50% loss in Year 1 leaves you with $50,000.
• A 75% gain in Year 2 on $50,000 brings your total to $87,500.
• A 0% return in Year 3 keeps your balance at $87,500.

Comparing the initial $100,000 to the final $87,500, you can see that your investment has actually decreased by $12,500. This equates to a total loss of 12.5% over three years.

The average annual return doesn't accurately reflect the actual performance of your investment. In reality, you have lost 12.5% of your initial investment, despite the seemingly positive average annual return.

Why It's Important to Know Your True Numbers

Understanding the true performance of your investments is essential for several reasons:

1. Informed Decisions: Accurate knowledge of your returns allows you to make better investment choices.
2. Realistic Expectations: Knowing your true numbers helps set realistic expectations for future growth.
3. Financial Planning: Properly assessing your investment performance is crucial for effective financial planning and achieving long-term goals.

Compare & Contrast

Brokerage Firm's Perspective:

• Presents a seemingly positive 8.3% average annual return.
• Uses a simplified calculation method.

True Perspective:

• Reflects a 12.5% total loss over three years.
• Provides a realistic view of investment performance.

Conclusion

As a financial advisor, my goal is to ensure you have a clear understanding of your investments. Don't be deceived by superficial numbers. Take the time to dig deeper, understand how returns are calculated, and always know your true numbers. This knowledge empowers you to make informed decisions and build a more secure financial future.

If you have any questions or need assistance in understanding your investment returns, don't hesitate to reach out. Together, we can ensure that your financial journey is based on accurate and transparent information.

Remember, knowledge is power in the world of investments. Make sure you have the power to make the best decisions for your financial well-being.