I was reading an article out of the Star Tribune based out of Minneapolis, Minnesota and I read this part of the article and I had to re-read it like 5 times. Now I’m not a financial planner, or the most savvy economist but read this and tell me if I’m missing something:
“Its combined funds for active and retired employees rose at an annual rate of 9.7 percent over the past 20 years, exceeding inflation by an average of 6.6 percentage points a year. The funds are expected to exceed inflation by 3 to 5 percentage points annually.”
So the funds are ‘expected’ to ‘exceed’ inflation by 3-5 points annually?
(click here for the full article)
Fuzzy Math.
My buddy Coby Tippetts calls this type of thing Fuzzy Math. See we are sold by people in the finance industry that our mutual funds are increasing annually an average of 9.7% but that doesn’t mean that every year your investment capital is raising an additional 9.7%. It is an average. If it is only outperforming inflation by 3-5%, then aren’t we only making 3-5% on our money? This is an example of a sacred cow. But there is another flaw in the ‘average’ retirement plan, read on…
Killing Sacred Cows.
This is the title of my friend Garrett Gunderson’s book and in it he has an example about this ‘average’ return that most people fail to realize. When you do the math on the returns it uncovers a basic assumption. In the book on page 70 Garrett gives this example:
“Suppose I have $1,000 to invest in a mutual fund.I invest it in a fund that has an estimated 10 percent return and enjoy a 100 percent positive rate of return the first year. Now I have $2,000. In year two the market actually drops 50 percent, leaving me with half of my $2,000, or $1,000. Year three results in yet another 100 percent positive rate of return, so again I have $2,000. Unfortunately, year four brings 50 percent negative yet again, so I’m back to my original amount of $1,000.
“The mutual fund company is pleased to announce a 25 percent rate of return on its prospectus for the last four years, but what does that mean for me? (Of course, this is an extreme example to prove a point. Mutual fund companies are much more subtle than this, because they would show the fund over a longer period of time so as not to highlight the wild variations in such a short period of time.)
“My actual return, as concerns he fund alone is $0 and 0 percent- or so it would appear. The situation is actually worse when we take into account inflation (which, generally speaking, is grossly underrated by most media), the capital gains taxes I paid in years one and three, fund expenses (because the mutual fund gets paid even for bad performance), and lost opportunity costs.”
He goes on in more detail of the actual math on ‘average rate of return’. I love his example and if you thought this was good you should read the entire book, it is available at your major bookstores and can be ordered online here at: killingsacredcows.com
I realized reading the book that I had many ‘Sacred Cows’ that I needed to murder in order to prosper.
Garrett titled his book ‘Killing Sacred Cows‘ and the subtitle is ‘Overcoming the Financial Myths that are Destroying your Prosperity.’ I have read the book a couple times and I think it is one of the best books on personal finance and the abundance mindset I have ever read. Anyone could read it and find it to be very valuable for their personal prosperity and financial education. Check it out and leave a comment here, I’d love to hear how much you like it.
Ben says,
Hey Man,
great article. I recently finished reaing Killing Sacred Cows. I found it to be an amazing help to me.
It has changed my mindset in so many ways and helped me see and understand my finances much more clearly. I like how it puts things so simply when financial institutions try to make things complicated and try to make you think they are the only ones that can understand that sort of thing!
Mostly it helped me understand the difference between Abundance and Scarcity. I think you actually recommended this book to me so thanks!
on March 31, 2009