Focusing too much on Rate of Return can result in long-term costly mistakes

So many people who I talk to about personal finance and investing are obsessed almost exclusively with what the interest return is on their money, referred to as Rate of Return (ROR), without truly considering the risks involved.

And too many people assume that the stock market, real estate, and other forms of investing will always create wealth in the long run.  While it’s true that most accepted financial instruments have gone up over differing time periods in history, the assumption that it will always continue to do so, under all circumstances, is both ignorant and foolhardy.

Just ask the tens of millions of folks who saw their investments shrink by as much as 70 percent during the downturn that occurred in both stocks and real estate less than a decade ago.

Putting your money into the stock market or real estate can be a boon, sure.  But there are major downsides.  It’s gambling for all intents and purposes, and therefore doesn’t strike me as the smartest thing we can do with our life savings, the funding of retirement, attempting to pay for college tuition for our kids, etc.

Consider this.  As I have demonstrated in a previous post (or two), average ROR isn’t the same as the actual return you get.  If you have Investment A which earns exactly a 10% annual return over, say, five years, the average ROR for that time frame is, indeed, 10%.  Likewise, if you have the following results over a five-year span:  up 20%, down 35%, up 40%, down 5%, and up 30%, you have an average annual ROR of 10% as well (the five annual figures add up to a positive 50%, divided by five years equals 10% per year).

But when it comes to the actual numbers, the first scenario – 10% each and every year for the five years – gives you about $1,552 if you started the stretch with a $1,000, while the second scenario leaves you with just $1,348 – more than $200 less!!  How can this be?  It’s because losses hurt more than gains help.

Let me illustrate that point with a question:  If you have $100, and you lose 50% the first year and gain 50% the second, you should be back to an even $100, right?  If you bit and said yes, it’s because you didn’t take the time to do the math.  Fifty percent of $100 lost the first year leaves you with $50, followed by a 50% gain the second year which results in your account balance being $75 (50% of $50 is $25, added to the $50 = $75).

Your net return was zero, yet you lost 25 bucks!  Mathematical fact of life, my friends.

The actual stats can be confusing, I realize, but don’t miss the inclusive point, which is that steady gains are more valuable than big years followed by significant declines, or losses followed by gains, or the two inter-mixed.

Everybody has been told that you need to have your money invested in the stock market, which can be most easily achieved if your job offers a 401K Plan, and if not you can open up an investment account or an individual retirement account, and get your money in the market that way.  Now tell me, after what I have demonstrated above, are you really sure that’s the way you want to go?

As the expression goes, “there’s got to be a better way.”

Well, folks, there is.  I’ve alluded to it, but not delved deeply, in previous posts.  We’re talking about the proper type of cash value, dividend-paying whole life insurance.  It’s the strategy of many of the country’s wealthiest individuals, but it is a game-plan that those of more modest means can utilize effectively.  It has numerous benefits, some that will really blow your mind (as they did mine when I first learned about this concept) with no significant downside.

Next week, I will write a more detailed (but fundamental) explanation of how the correct type of whole life insurance can replace any and/or all of your other financial and investment instruments.

For now, here’s a teaser benefit:  You can know within about 90% accuracy how much money your policy will build, in advance, based on a fixed ROR combined with annual dividends that, while not guaranteed, have been paid out every single year for the last CENTURY by the top companies who specialize in these types of policies.  And all the while, your money isn’t invested in the ultra-volatile stock market, and so you’re not dependent on its whims.

Seriously, this stuff is really cool.  I look forward to going into more detail next week.  Until then, as always, thanks for reading.

***

DISCLAIMER:  This post represents the author’s opinions only.  In no way should any part of the content of this post be interpreted as official financial advice, nor does it represent an intention to solicit readers into a specific company or investment.  Results are never guaranteed.  Utilize the information as you see fit, make all money decisions at your own risk.

Leave a Reply

Your email address will not be published. Required fields are marked *