Myth #5: Average vs. Real Returns

Summary: In their marketing materials and annual reports, Mutual Funds are legally allowed to display their returns as average returns (not the real or compound rate of return). This is incredibly misleading and yet this seems to be the metric of choice when selecting the “best” managers.

The Numbers: When we look at the example, we will see that the average return, the way Wall Street would calculate it, is much different than the real or compound rate. Adding or subtracting the annual returns and dividing by the number of years calculate an average rate. Although this sounds reasonable, lets look at a 4-year period in which the average return is 0% while the real return is drastically worse (down 43.75%). So while managers may boast of their average returns, you will always want to know the true compound/real rate of return because what matters to you is how much you can spend when you need it the most.