When Your Average & Actual Returns Are the Same- and When They Are Not

Did you know?! Your average return is not the actual return on your investments.

Wait what?! 😮

When I log into my 401k portal, they tell me that my average return is 9.47%. That means that I have 9.47% more money… right? 🤔

Sadly… the answer is “no”. Most people’s retirement accounts are solidly invested in the stock market. And the stock market, as we know, can rise in value… or fall in value.

Here's how it works: When you lose 10% of your money, you have 90% left. (Duh, Melissa.) When you gain 10% back... you have 99% of what you started with. That's a 0% average return, and a -1% actual return 😖

For example, if you have $100,000 in your investment account, and you lose 10% this month, you’ll have a balance of $90,000 in that account. Then let’s say next month is great and you gain 10%. You will then have $99,000 in your account.

Your account management firm will tell you- correctly- that your average return over the last two months was 0%.

-10% + 10% = 0%

So what is your actual return? What does that mean? The easiest way to remember is your actual return refers to the actual amount of money you have gained or lost, and is written as a percentage. In our example:

$100,000 - $10,000 + $9,000 = $99,000

$99,000 / $10,000 = -1%

A second way to say it- your average return calculates returns based on percentages. Your actual return calculates returns based on dollar amounts 👍

And- this is a rule of math- when you include any negative numbers in an average, your average return will always be lower than your actual return 😒

Ok, duh, Melissa. That’s normal- that’s how investments work!

Well, yes; that’s what we are conditioned to believe. We are conditioned to believe that investment losses are inevitable. We are conditioned to think that “what goes up, must come down”, or maybe “you can’t grow your money without putting it at risk”. And this conditioning is normal- most of us do not receive a great financial education in school; we pick it up over time, from many different sources.

But there are vehicles called indexed accounts (IAs) that have been around since 1995- that’s older than Roth IRAs!- and they have exploded in popularity. A type of IA called an indexed annuity had $100 million in sales by the end of 1995.

Fast forward 17 years. By the end of 2012… companies reported $34.2 billion- with a B- in indexed annuity sales 😲🤑

These indexed accounts can protect you from loss. This means that you will never lose money in your accounts; 0% is the lowest amount of money that your investment account will see. And again- those rules of math come into play. When you are only adding zeroes and positive numbers together, then your average return is always the same as your actual return.

This is an interesting financial education concept… but this may not seem very useful.

Au contraire, friend! When you log into your accounts, or look at your balances, you may be seeing a fairly high percentage in the “average return” column. But it might not make you feel very good when you look at the “account balance”. If, like many people, you feel a cognitive dissonance between your account balance and your average return- then you’re not alone. And you certainly aren’t crazy!

Now you know two new things. First, that your actual return will always be lower than your average return, if your money is invested in places like the stock market that experience both ups and downs. Second, that there are vehicles- fairly popular ones- where you will never lose money. And in those accounts, your actual return will always be exactly the same as your average return.

Now That’s Smart Money 🧐