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Jul 24, 2022

Having been in the financial services industry since 2000, I’ve noticed that almost all investment product companies (mutual funds, ETFs, stock market indices, variable annuities, closed-end funds, REITs) love to cite their “average annual rate of return” figures which always inflate what the particular investment actually returned to its investors. And it really bothers me.

2+2 always equals 4...except on Wall St.

This problem isn't complicated nor is it really nuanced in any particular way,(as the investment industry would have you believe) it really comes down to basic math.

Average annual return, as is always stated in investment literature, (marketing pieces, prospectuses, etc.) is simply a deliberate shell game meant to confuse your perception of the returns by stating simple arithmetic mean calculations when the only return that matters is the compound annual growth rate (CAGR).

Now, I know it sounds like I'm splitting hairs here but hang with me through an example and you'll understand my beef.

Example :  Let’s say that Bill invests $100,000  into his investment account at J.T. Marlin (some of you may get the Boiler Room reference) and for the 1st year  his account grew by 25%  but the account  returned a negative 25% the second year.

The stock market muppets would say your average return is 0%...and they’d be telling the truth…in the same vain that President Clinton swore he did not have sex with that woman.

But they are clouding the truth with nonsense--because who cares what your average rate of return was?

Year 1—   100,000 x     25% =    125,000

Year 2—  125,000 x (-25%) =    93,750

If Bill started with 100k and now at the end of year two his account is worth $93,750 his actual compound annual growth rate (cagr) was -6.25%.

But didn't I prove in the example that his average annual rate of return was 0%?

Then, how can Bill have less money than what he started with?

Welcome to the wonderful world of investments and the Imagineers of Wall St.

I actually found this little tidbit online when looking around to see what others were talking about in regard to CAGR.

Investopedia.com says:

“CAGR isn't the actual return in reality. It's an imaginary number that describes the rate at which an investment would have grown if it grew at a steady rate. You can think of CAGR as a way to smooth out the returns.”

Honestly, I’m speechless.

The Enron accountants have obviously taken up residence on Wall Street and are firmly rooted in content publishing for the financial media.

I beg to differ with Investopedia
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