16: The Dangerous Illusion of Average Returns
016 Average Returns Main Recording
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Introduction and Common Financial Advice
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John Perrings: Okay, let's start with a question. How many of you have ever been told something like this? Just invest for the long term. Even when the market goes down or it goes up, keep putting your money in there and keep investing and over the long term, you'll get a high average rate of return. Often we're told things like 8%, 10, even 12% a year, just depending on who you talk to.
This is one of the main talking points of conventional financial planning, and it's the reason so many of us have our money in autopilot going into things like 401(k)s, IRAs, or even regular brokerage accounts, and a lot of times we're buying things like the S&P500 index funds as kind of the common conventional thing to invest in believing that as long as we stay with it, everything will turn out okay.
Well, today I'm gonna demonstrate that the logic behind average returns is not only statistically flawed, but practically speaking, it's likely dangerous to your financial future.
This is Stacked Life, the podcast that teaches you [00:01:00] everything you need to know about The Infinite Banking Concept,
whole life insurance, and the strategies that make it all work. And I'm John Perrings, an authorized Infinite Banking practitioner. I've implemented IBC for hundreds of my clients and educated thousands more with original content from my podcast articles and courses at StackedLife.com.
Debunking the Average Rate of Return Myth
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John Perrings: In this episode, we're gonna take a hard look at one of the biggest myths in personal finance.
You're gonna learn why the. Average rate of return has almost nothing to do with what's actually happening to your money and how this misunderstanding can cost you years of financial progress.
Here's what we'll cover: first, the statistical error everyone's falling for will break down the flawed math behind rolling averages and why it creates a false sense of security.
Number two, the real world consequences. I'll show you the actual periods in history where the market average was positive, but investors actually lost money over 10 or more years. Next, you'll learn why even by playing by the [00:02:00] conventional rules, your actual return is likely to be lower than your average return about 75% of the time.
And then finally, we'll talk about what to do instead. How to build a financial foundation that doesn't rely on guesswork and hope. So let's get into it.
Statistical Errors in Rolling Averages
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John Perrings: The first problem with the whole average rate of return idea is really the math itself. The entire idea is a smoke and mirrors game that I think a lot of people really need to pay more attention to. A lot of times when you talk to a financial planner or read an article, they'll analyze the market using these rolling 30 year averages.
What that means is they'll take a 30 year period, let's say 1930 to 1959, and they'll get the average return experienced over that 30 years. Then they'll take the next 30 years, 1931 to 1960, then 1932 to 1961 and so on. And if you do this for the entire history of the S&P500, for example, you'll get [00:03:00] about, well, right now, you'll get 66 of these 30 year periods.
This gives the illusion that we have a significant amount of data to pull from to build a credible market history that then we can make some other assumptions on. And one of the crazy things is that we all know we're not supposed to actually do this. We're not supposed to use past performance to predict the future.
It's printed on pretty much every one of your documents or your statements that you get from any of your investments. That's exactly what's happening. All of these sophisticated models like Monte Carlo simulations and other things, that's what they do. They just look at the past and tell you what you can expect and and give you assumptions on what you can expect in the future.
But even if we say that that's not a problem, there's still a major statistical error that everyone's kind of unfortunately falling for, and it could cause some major damage. I learned a useful analogy in the statistical analysis behind it from a man named Dr. David Babel, an internationally recognized [00:04:00] finance expert and professor emeritus at the Wharton School.
He unfortunately passed in 2021 from Leukemia, but he did some excellent work. And the analogy goes like this. Imagine you have 30 people in a room and you weigh each person to calculate the average weight of the people in the room. Then you swap out just one person and recalculate the average.
It's pretty easy to see that swapping out one person isn't going to significantly change the average weight because you've shared 29 out of the 30 people from the previous sample. Well, this is exactly what conventional financial models do.
The 30 year period from 1931 to 1960, for example, shares 29 of the same years from the previous 30 year period from 1930 to 1959. It's a statistical problem called auto correlation or overlapping data where the data isn't independent and in fact, in this case, it's almost identical.
So [00:05:00] here's a little bit of a reality check. In the last 95 years of market history, we haven't had 66 different 30 year experiences. By the way, 66 data points are not statistically significant either, but we don't even have 66, we have three.
We have three non-overlapping 30 year periods over the entire history of the S&P500. And if you wanted to look at the experience of a complete financial life, including retirement, that'd be like a 60 or 70 year period.
And if we want to analyze that, we'd actually only have one single data point. To get the data we think we're getting from these rolling 30 year averages, we would actually need 30, 30 year periods or 900 years of market history. And of course we have nowhere near that, and this isn't theoretical, by the way.
Real-World Consequences of Misleading Averages
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John Perrings: These statistical errors have real world consequences. And I'm talking about significant periods of time where we've had no [00:06:00] growth from a real return perspective. And so, something to understand is that when you calculate an average rate of return, you're just doing a mathematical average on the annual percentage numbers. That has almost nothing to do with what actually happens to your money when you're continuously adding or taking away from it.
If you just have a lump sum and you calculate the average on that, it actually will be correct. But anytime you're taking money out or putting money in, it completely changes everything. And now you have to, now you have to look at the time value of money to calculate the real return behind that.
So let's look at an example.
Examples of Misleading Market Returns
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John Perrings: Let's look at the 10 year period from 1998 to 2008. Actually, this is an, that's an 11 year period, but if you take the simple average of the S&P500, with dividends reinvested, and you're investing $10,000 per year, the average return was 3%, which by the way, is not even close to what we're told we get with the s and p with [00:07:00] dividends reinvested. But even aside from that, the real return was negative 3%, 2.7%. Now, I know I'm kind of cherry picking a period of time here, but the point is not about the growth of the loss. The point I'm making is about two things. One, that you can have a positive average return and still lose money.
Not many people realize that and that.
And number two, that the real experience that we have doesn't at all follow a 30 year or an all time market average, which is what everyone is using in their financial plans. What we have here is an 11 year period of slightly negative, let's just call it zero, growth. And it really, really matters when this happens. Can you imagine getting zero growth in your retirement account for the first 10 years you started it, or the last 10 years before you retire, or for the first 10 years of while you're retired, when you're actually taking money out?
If you [00:08:00] think about this, for a decade, that's a third of someone's career. Essentially, you're planning on earning eight to 12% while your portfolio is actually losing value or staying stagnant. And the thing is, this isn't a fluke. It's not a one-time event. I've looked at a lot of these numbers and if here are a couple examples.
From 1962 to 1974, a 13 year period, the average return of the S&P500 with dividends reinvested was. 2.5%, but the actual return was a negative half a percent, basically zero growth. And again, this is in the S&P500 with dividends reinvested, which is often considered the gold standard of passive investing.
And if we look at the S&P without dividends, which, a lot of people have money in this because they're, you know, in your 401k or mutual fund or whatever it is you're invested in. A lot of them do not partake in the dividends. And looking at the S&P [00:09:00] without dividends, there was a 20 year period from 1955 to 1974 of slightly negative growth at negative 0.14%, essentially zero growth, from a real return perspective.
Here are some interesting facts. There are seven, 10 year or greater periods when the S&P500 with dividends reinvested showed a positive average return, but had a negative actual return. And for the S&P without dividends, there are 24 of those periods. The longest being 20 years that we just mentioned.
That's 20 years of no growth. That's two thirds of someone's working life.
The Reality of Long-Term Market Performance
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John Perrings: So. The thing to take away from this, I think, is that averages can and do lie, and they can lie for a very, very long time. And it's, in my opinion, completely inappropriate to take an entire market history average and try to apply that to your specific timeframe.
Anything can change in a [00:10:00] 30 year period. If you experience zero growth for 10 or 20 years, how much faith do you really see yourself having that the next 10 are gonna make up for the first 10 to 20. Here's another thing. Going back to those flawed rolling 30 year averages that we discussed earlier.
I discovered a pretty crazy trend. I looked at all the average returns of every 30 year period in the history of the S&P. The actual return, the real growth on your money over 30 years is lower than the simple average return over those same 30 years, 75% of the time. So to say this another way, 75% of the time, the real return is less than the average return over that same 30 year period.
Now my analysis here suffers from the same overlapping sample problem I mentioned earlier, but I'm bringing it up to demonstrate that even when we use the status quo methodology, the [00:11:00] data shows that the average return that they promise is not what investors actually get. People are planning their lives according to these numbers, these averages, when even by the industry's own rules, it only comes true 25% of the time.
So a little bit about why this happens. Well, we're often told when we invest for the long-term and markets go down, we're told about dollar cost averaging that we want to be disciplined long-term investors, and when markets go down, you keep buying shares at a lower cost.
And that's true. It's a good thing because the lower cost on those shares creates a higher average return on the total. But what's never discussed is the other side of that coin, if you're investing every year for the long term, you'll also be buying shares when they're at all time highs. When you buy at all time highs, wouldn't you create a negative dollar cost averaging effect on your total return?
And if you think about it, you really only get a positive [00:12:00] dollar cost averaging effect three out of every 10 years on average. There's typically three of every 10 years the market goes down. The other seven, you're potentially getting a negative averaging effect because you're buying it newer and newer highs all the time.
And no one talks about this the other. Weird thing, just as a quick aside, is that people, I just think it's funny. People talk about dollar cost averaging as if it's this unique kind of side strategy of investing for the long term. And people talk about it like they're, you know, a savvy investor.
But it's funny to me because the number one rule of investing is buy low, sell high. So, by that rule. Shouldn't we be buying all of our stocks like we do when we dollar cost average? Why are we only doing it three out of every 10 years?
And so at the end of the day. In my opinion, a lot of these ideas are just rationalizations to get people to feel comfortable with the significant risk they're taking when they invest in the stock market.
Yes, Invest, But Also Do This
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John Perrings: [00:13:00] And now, so let's talk about this. I'm not trying to say that it's bad to invest in the stock market, and I'm not saying don't do it, but I think we should just be honest about the risk we're taking.
Everything's great when the markets go up, but it really, really matters what's going on in your life when they go down. Are you in a job that could be affected by that? Are you gonna have to liquidate investments just to live? What if you're retired and you have to take money out while the markets are down?
The big problem is most of us have our entire financial lives and our entire financial future tied up in this system where we don't really have any control, and we're just passively hoping that our 30 years won't be one of the bad ones. The lowest 30 year return on the S&P500, by the way, from 1945 to 1974 was 4%.
Imagine showing up on the day of your retirement and having one half to as low as one third of what you were planning on having.
Building a Safe Financial Foundation
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John Perrings: So instead of trying to make the [00:14:00] risky market be something that it's not, my suggestion is this, keep investing. Do it. Do your investing in the market if you want, but have some part of your financial life that truly is safe.
Build your financial foundation first in a system that's entirely in your control and out of the hands of people that put it at risk. Then once you have that foundation built, you can afford to take some risk, a little bit of risk without having to restart your entire financial life if any one thing goes wrong.
Stacked Life's Approach to Financial Security
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John Perrings: And that's what we do at Stacked Life, by the way. We show you how to use strategies, combining whole life insurance to start as your foundation, an asset class with guarantees and certainty. And then we combine those with private wealth strategies to build a platform of constantly improving cash flow and liquidity that then creates growth and certainty.
We can help you get massively improved outcomes with safety and control so that you can take advantage of the change that we always know is coming [00:15:00] rather than just react to it.
Free Financial Assessment
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John Perrings: Now if any of this is resonating with you, listen up, I'm doing something new. I'm offering a free 20 minute financial assessment. This is a non-numbers based one-on-one assessment directly with me. But this isn't one of those things where I'm assessing you based on where I think you should be, it's designed to help you bring light to where you think you are in four key areas: your current financial position, your future financial outlook, your readiness and flexibility to make shifts in your strategy for improvement, and then a snapshot of the support and expertise that you have around you to help build your financial future.
From this, we can determine your next best financial move and whether or not what we do might help you with that. So schedule your free assessment today at StackedLife.com/Assessment. See you on the next one.
