http://www.huffingtonpost.com/natalie-pace/beware-of-20-returns-5-wa_b_3343237.html
Over the last month, I've been hearing countless financial professionals boasting of 17-20 percent returns over the last three years. And like anyone, I was amazed. Until I did the math.
NASDAQ has doubled since 2009, putting the annualized return at 25 percent over the past four years -- meaning anything below that is performing below the general market! Also, the three-year performance metrix is conveniently shaved to exclude the Great Recession. Most people bragging about 20 percent gains are covering up the fact that their clients lost way too much during the Great Recession and are still underwater -- even with a robust bull market.
So, rather than being wowed by what is basically a market recovery, sober up and examine the data that really matters. Today's bull has been (and will continue to be) a bucking bronco that has left most riders bruised, broken, weary and rattled.
5 Ways to Separate Superior Performance from Salesmanship.
1. Ask for the five- and 10-year Performance
2. Discern between Cumulative and Annualized Gains
3. Do a Stock Report Card
4. Examine the Credit Risk
5. Read the Fine Print
And here is more information.
1. Ask for the five- and 10-year Performance.
Below is a 10-year performance chart of large caps, small caps, bonds, gold, real estate and Treasury bills. As you can see, diversification is key. So, is a sober understanding of average ROI of each asset.
Twenty percent annualized gains over three years is a losing proposition if the performance during The Great Recession was -- 50 percent, as you can see clearly in the illustration below. If you lose 50 percent of your nest egg and then earn back 20 percent annually, you'll still be down almost 15 percent because it takes twice as long to crawl back to even when you lose that much money.
$1,000,000 goes to $500,000 (when you lose 50 percent)
$500,000 becomes $600,000 (with 20 percent gain)
$600,000 becomes $720,000 (with 20 percent gain)
$720,000 becomes $864,000 (with 20 percent gain)
You are still down $136,000 in this scenario
Conversely, if you diversify, keep the proper amount safe, know what safe is and rebalance your nest egg annually, then you'll be enjoying well above the average 10-year gains, without risking the devastating losses.
2. Discern between Cumulative and Annualized Gains
Some salesmen will show you cumulative gains for added wow factor. One-hundred percent cumulative gains over a 20-year period is only 5 percent annualized, a very low rate of return on investment. Whenever you see the word "cumulative" you have to divide the return by the number of years to get the annualized return.
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