Average Rate of Returns vs. Actual Returns

In this blog post, I am going to talk about Average Rate of Returns vs. Actual Rate of Returns and how the cost to recover your money can be very high.

If your money is invested into an investment vehicle where you could lose money, it can have a compound effect on your overall portfolio. For example - let’s say if Mr. A & Mr. B invested $100 each into the stock market. 

Scenario -1 -

	Mr. A	Mr. B
Year-1 Rate of Returns	+50%	0%
Year-2 Rate of Returns	-50%	0%
Net % Return	0% (50 - 50)	0%

By looking above, you see that both had a net 0% Average Rate of Returns. If the market goes down 50%, and after some time it comes back up 50%, everything looks good on the surface. Most of the people including advisers say that everything is good as the market has come back up to the same percentage. But, has your money come back up to the original level? Let’s have a look -

Now let’s look at Actual Rate of Return -

	Mr. A	Mr. B
Initial Amount	$100	$100
Year-1 Returns in Amount	+$50 (+50%)	+0 (0%)
Year-2 Returns in Amount	-$75 (-50%)	+0 (0%)
Net Amount	$75	$100

If you look above at the actual returns, Mr. A lost a net of 25% of his money, while Mr. B didn’t lose anything. 

Scenario - 2 -

	Mr. A	Mr. B
Year-1 Rate of Return	+40%	10%
Year-2 Rate of Return	-20%	10%
Net % Return	20% (40 - 20)	20%

By looking above, you see that both had net average 20% Returns.

Now let’s look at Actual Rate of Returns -

	Mr. A	Mr. B
Initial Amount	$100	$100
Year-1 Returns Amount	+$40 (+40%)	$10 (10%)
Year-2 Returns Amount	-$28 (-20%)	$11 (10%)
Net Amount	$112	$121

In this scenario, Mr. B gained more amount than Mr. A, while their Rate of Returns looked the same on the surface. This is what the difference between Average Rate of Return & Actual Rate of Returns is.

As you can see, any loss to your investment can have a compounding effect on your portfolio, so invest wisely.