What You May Have Missed

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Published: Tuesday, July 29 2014 6:00 a.m. MDT

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Dave is such a genius. Here's what he's really selling you at 12% when he says AVERAGE.

Imagine I say I have an investment that will average you 25% a year for four years. How much would you want to invest? Let's say 100K.

So the first year we have a stock market that gives you a 100% return the first year. Great!

Second year its like 2008 all over again and you lose 50%

Third year we get that 100% return again. Awesome.

Fourth year we lose 50%.

At the end of the year I knock on your door and give you a check for 100k and you say, "What's this? I thought you said I'd get 25% on my money?"

I say, "I did exactly what I promised!"

100% first year

-50% second year

100% third year

-50% fourth year

----------------

100% / 4 yrs = 25% avg. per year and you didn't make a penny!

AVERAGE rates of returns mean nothing.

One of the keys to making money is never to lose it in the first place. Avoid risk and avoid debt.

Dave Ramsey says to never gamble with your money yet out of the other corner of his mouth he's pushing people into the stock market.

sammyg: Your calculation is wrong.

In the scenario you have given, the average rate of return is 0%, not 25%. When calculating average rate of return over a given period, take the ending dollar amount minus the starting amount, all divided by the beginning amount. In your example, that's 100 - 100 / 100, or 0 / 100 = 0%.

To get 25% over four years, the final amount would have to be something closer to $200k.

Dave is correct that over the long term, the stock market has returned about 12% average. That means that if you had invested $100 30 years ago, the value today would be about $2675. The years that it has gone up has more than offset the years that it has dropped.

ewatts math is correct.

Dollar cost averaging in index funds. My goal is to match overall economic growth while incurring as few fees as possible.

sammyg,

I feel bad that you've missed out on great opportunites to make money in the market. For example, I've owned one mutual fund over the past 22 years (since I was 8 years old), and have had a 565% return (as of today). Boy do I love that compounding income return! Those who understand interest make it, those who don't lose it. You holding onto your cash is losing money everyday because of inflation! Now that's a risky bet!

So, sammyg,

Are you then suggesting that we all hide our savings under our mattresses and let inflation eat it away?

Also, as others have noted, your math is incorrect.

ewatts, Floyd Johnson, Aggie238...

I thought this Investopedia definition of 'Average Return' was just simpler to paste for you guys since you're having so much difficulty with this concept...

"Definition of 'Average Return'

The simple mathematical average of a series of returns generated over a period of time. An average return is calculated the same way a simple average is calculated for any set of numbers; the numbers are added together into a single sum, and then the sum is divided by the count of the numbers in the set.

Investopedia explains 'Average Return'

For example, suppose an investment had returned the following annual returns over a period of five full years: 10%, 15%, 10%, 0% and 5%. To calculate the average return for the investment over this five-year period, the five annual returns would be added together and then divided by five. This produces an annual average return of 8%."

100 - 50 + 100 - 50 = 100 divided by 4 = 25

My math is correct. 25% Avg. ROR with ZERO yield.

I'll expect an apology from everyone of you for the above.

My point in all of this was to show how misleading percentages are. I did that, you missed it.

Percentages are mostly hype without more data.

Sammyg,

Your assertion makes no mathematical sense. In any scenario, financial or otherwise, an average rate is *always* calculated by subtracting the initial quantity from the final quantity (or, displacement) and dividing by the some interval such as a time interval over which the data was taken. We do the same thing in calculus except we use the differential of those quantities to calculate the instantaneous rate of change. This basic concept of averages holds true whether you're calculating the average velocity of a car (rate of change in position), the average rate of population growth of frogs, or the average return on an investment. To get it as a percentage you simply divide the average rate that you got by the initial quantity and multiply by 100.

This is supported by the Farlex Financial Dictionary under Average Rate of Return.

The reason for calculating average rates of change in this way is because we can calculate for an infinite or uncountable set of values. This would be particularly true for an investment which changes almost by the minute. It also eliminates the problem you pointed out of drawing incorrect conclusions from the data set.

aggies123

Once again you're complicating things. Go back and reread everything.

I simply stated my AVERAGE for four years in the example was 25% but my yield was ZERO. It's an extreme example. It's misleading but it is as true as stating the stock market averaged 12% over whatever span of years when in fact my actual return was 8.21% or whatever is calculated.

Simply pointing these things out.

When Dave Ramsey says the stock market averages such and such, what is he talking about? He's simply stating an average that he finds on a piece of paper and that average is calculated exactly as it was described in that Investopedia definition I found for you. It is deceiving until you get a financial calculator and add a dollar in the market... then you get your yield. Then you can calculate your real ROR and average that over whatever time you want.

Dave's simply throwing a number out. It's disingenuous and deceiving to the average investor.

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