Actual vs Average Rate of Return: Stop Buying the Hype

Whenever the media discusses a market index’s return, or when mutual fund companies promote their returns over the last 3, 5, and 10-year periods, they always reference the Average Rate of Return.

The average rate of return has been accepted as the standard in today’s world and nobody even bats an eye at it. Even when I help people plan for retirement or when I’ve discussed an investing post on this blog, I always calculate things based on the average rate of return. For instance, if you invest $500/month for the next 25 years, and assuming you earn an 8% average return, you should be able to retire with no problem.

However, have you ever been one of those people that have said: ‘I know they claim the S&P 500 has AVERAGED 14% over the last 3 years (true story), but I haven’t gotten anywhere close to that! I’ve only made 10% even though I’m in a S&P 500 Index Fund!’?

Average vs. Actual Return

If you’re one of those people that have wondered why you never get the same returns that people claim the market is averaging, then I’m happy to tell you that you’re not crazy!

To get my point across, lets play a game today! No trick questions by the way.

So, based on the chart below, what is the Average Rate of Return?

The average rate of return graph

The average rate of return is 0%, right? 5 years of +10% gains and 5 years of -10% gains would come out to a 0% average rate of return.

Now, let’s take this a bit further…

Let’s assume that you invest $1,000 and the exact same scenario takes place: up 10%, down 10%, up 10%, down 10%…and so on for 10 years total. Who out there believes that you’ll still have $1,000 left in your investment account after the 10-year period? This blog thing really isn’t a good medium to ask questions…dang.

Do the math, it’s quite fun:

Actual Rate of Return graph

Well, the truth is that you will only have $951 left in your account! Good for a -4.9% Actual Rate of Return.

Stop Buying the Hype, You’ll Never Realize The Average Rate of Return

As we can all see from the example above: it is mathematically IMPOSSIBLE for you to realize the average return if there is ever a negative day, month, or year in the market.

This holds true for returns on precious metals, returns on individual stocks, and especially returns on mutual funds. The average rate of return isn’t really what you earn, so stop paying attention to it!

Just to make my final point: the S&P 500 averaged a 2.11% rate of return for the year of 2011. However, if you were to have invested $1,000 on January 3, 2011 (the first day the market was open last year) and pulled your money out of the market on December 30, 2011, you would have made a whopping $3.55. Also good for a .355% Actual, Realized Return.

A 2.11% average and a .355% actual return are quite different. The statistics say there there is about a 1-2% difference in the average returns that the media/mutual fund companies promote and what you realize as your true return.

Has it ever occurred to you that you’re not earning the “average” rate of return? Do you think it’s wrong that mutual fund companies and the media promote average rates of return?

Editor’s note: I don’t believe promoting the average is wrong or misleading. The numbers they promote are truly the average; we just haven’t been savvy enough to know there is a difference between the average and actual. It’s like understanding the difference between median, mode, and mean.

About the Author

By , on Sep 24, 2012
Andy Tenton
Andy is a 30-something New Yorker who turned his financial life around. He took charge of his finances, got out of debt, and is now working his way toward financial success. He is the publisher of

How to Become Rich e-Course

Budgeting 101


  1. Shilpan says:

    Indeed, last decade was a lost decade in terms of return on your investment. I also agree that media hypes about the average return to make you feel good.

    I suspect that mutual funds must be using long term, 30-50 years, to smooth out major move in either direction. Also, they never mention effect of inflation on your return.

    And at the rate our government is printing money, even if you earn 6-8% return, dollar will be worth much less in next 20-30 years.

  2. Andy Hough says:

    You did a great job of comparing the actual rate of return to the average rate of return. People also have to realize that there will be big swing in their returns and any individual year is unlikely to be average.

  3. Yeah, I always thought 8% was a bit too optimistic, lol. I do still believe in saving and investing, but I think all sorts of diversification is a good idea. Why not invest and have some rental property? Or come up with other ways to bring in monthly income consistently outside of your “real” job? I’m hoping by covering a lot of bases, my husband and I will be financially independent by our 50s without depending solely on interest rates…

  4. Jonathan says:

    The average that you are looking for is the geometric average which takes into account the affects of annualized compounding over the stated period, it is important to note that geometric average is a time weighted return and is not affected by the timing of cash flows or dollar cost averaging which can distort the time weighted average in either direction (an accurate measure of dollar weighted returns is derived with the harmonic mean).

    When looking at the potential returns of any asset class you have to look at the distribution of returns. Typically fund companies state the average for a ten year period and people think that is what they will get on an annual basis. Foolish assumption at best.

    Currently the 10 year average for the S&P from Jan 1991 to Dec 2011 is around 10.64% with a standard deviation of 18.82%. Two deviations from the mean will give you a 90% probability that the range of returns for the S&P 500 will be anywhere from -27% to 48.31%. Statistically speaking, the odds of your return being identical to the geometric average are pretty slim.

    If anything, the fund companies are taking advantage of most individuals ignorance of statistical measures as opposed to “marketing” an average one, two or five period return that is most definitely not “false” It is just taken out of context and assigned an unreasonable expectation by novice investors. This type of ignorance is why the majority of the investing public, sucks at investing.

    Technically, the example (and its associated distribution of returns) you provided is more suitable for binomial options trees with two specific probability outcomes that grow by a square at each point in the tree. Although, it is a technicality that doesn’t detract from your merits of your original point =)

  5. We learned at FinCon, from Liz Weston, that averages lie. This is another example of that!

    • Andy says:

      Kathleen, I’m jealous that I couldn’t make FinCon. ๐Ÿ™ Thanks for bringing that up again. LOL. Averages do lie and I REALLY get annoyed when people use them. It’s like when people talk about the AVERAGE in 401(k) or retirement accounts. Heck, we did a presentation for the Royals a few years back, and all you hear about NFL or MLB salaries are the AVERAGE. In those scenarios, it’s more important and realistic to know what the mean is because there are outliers that completely skew the data and totally throw off the averages.

  6. Andy, you make a great point here. It is misleading when the actual rate of returns are not included also. Having just the average rate of return instantly makes you think that it is actual (a good marketing trick). Showing both to the customer makes it very clear what both really mean.

    I remember this the next time I look at a new investment!

    • Andy says:

      Thanks Andy. As I mentioned to a previous commenter: it’s impossible for them to give the “actual” because it’s different for every person. It depends when they bought the fund and that changes daily. In the event of ETFs or stocks, that changes by the second.

  7. Great post Andy! One thing that investors have to keep in mind as well is that in order to earn an average rate of return the investor has to stay invested over the long term. Many times, investors sell when the market drops and buys after it has come back up. You’ll never come close to meeting your goals.

    • Andy says:

      Despite all of the promoting around timing the market, all of the studies show that people who get in and then get out NEVER come close to AVERAGING what the market would have given them.

  8. Really good point, Andy.. I often hear the “Average Rate of Return” used in calculations for retirement, long term savings, and more.. And the reality is, there could be a rather dramatic variance from this number..

    • Andy says:

      The reason nobody promotes the “actual” is simply because it’s different for every single situation…so even when I help people assume a rate of return in retirement planning, I use averages. However, I try to use a conservative average rate and therefore hope I’ve factored in what their actual will be.

  9. Thank you for spelling this out! I’ve always thought that people touting the “average” were overshooting it. Sounds like they weren’t lying, but the average person may not catch the subtle (but important) difference because average and actual.

    I need to check up on my 401k and Roth IRA to see what my actualy return has been…

    • Andy says:

      I think it’s important to know the actual, but be careful when you check your 401k: many companies INCLUDE your contributions when THEY show you your “actual” return. They show your balance as of Jan 1, 2012 and then your balance now and state that it’s your “actual” return, however that’s not the case as it includes your contributions. ๐Ÿ™‚ Be weary of the tricks!

  10. This makes a lot of sense-your explanation was thorough and helpful. I really had not considered this.

    But if one year I increase, but the next year I decrease, the following years increase (if it holds that pattern) would be an increase off of my lowered amount.

    Thank you!!

    • Andy says:

      Thanks, Todd! I’m glad it helped. All of the math stuff and terms can be really confusing for people. We do a lot of seminars for retirement planning and I’ve found that not many people outside of personal finance realize there is a difference between their actual return and the average the mutual funds promote.

  11. You make some good points about using the arithmetic mean (common average) when looking at returns. I’ve mostly got myself trained to look at CAGRs, which while they have their own weaknesses, at least don’t seem quite as prone disappointing than averages.

    • Andy says:

      I read up on the CAGRs and all of the technical terms really confuse me. Admittedly, I should know these things and the definitions of each, but I can’t say that it’s my strength. I just know there’s a difference! ๐Ÿ™‚

  12. Very well done, Andy. Being a numbers guy, I really dig posts where we run through the numbers. I also wanted to understand the difference between these two statistics and even published a post on this back in June:

    Basically one value accounts for the affects of compounding (geometric mean) while the other does not (arithmetic mean).

    Most higher level media sources and books have been smart enough to use the geometric mean as the value they report (as they should). For example, when you read in books that the S&P 500 has returned 8% since [whenever], that’s the geometric mean they are reporting.

    But not all media sources get it right and I have noticed mistakes! People would be wise to at least understand that there is a difference. This is particularly important when someone tries to quote you an investment. As I show in my example, it’s pretty easy to make an 8% geometric mean look like a 20% arithmetic mean if you use the wrong value!

    • Andy says:

      Sometimes I do my best to break things down so the simpleton can understand things. I like breaking numbers down for us “nerdy” people, but sometimes I think we go too far and it becomes confusing for people (i.e. like all of the technical terms). ๐Ÿ™‚

  13. Modest Money says:

    Good points Andy. I admit that I don’t do enough planning to actually have set rate of return in mind. Currently I just try to make the best investment decisions based on what data is available to me. I realize that I may get a lower rate of return than I would hope for, but it’s not something I stress out about. I know that if I keep investing in strong investments, I’ll at least make some money off of that investing.

  14. Thanks for highlighting the math on this subject! I agree with Kurt that I always look at the historical return for comparison, not the average. The average isn’t wrong, but it is a bit misleading if you don’t realize what you’re getting.

  15. I think you just have to plan to be in it for the long term and can’t get too bogged down by annual returns. People get so upset because they “lost’ money in the stock market. You don’t lose it until you sell for a loss. Dollar cost averaging over time into low costs funds and you should come out OK.

    • Andy says:

      I don’t think it’s safe to assume…especially if you don’t fundamentally understand how returns are averaging. If you don’t know how to plan (considering you don’t know what rate of return to use), then that doesn’t help you any. That’s like blindly stashing money away and hoping that it works out. As a financial advisor and planner, I can’t suggest that to somebody. ๐Ÿ™‚

  16. AverageJoe says:

    You’re also making a great case for dollar cost averaging here, Andy. If someone would have placed money in the market at each of those inflection points instead of all at once, they would have done much better.

    • Andy says:

      Joe, take a second and do the math…because that’s not true. If you started with $100 and put in $100 each year for 10 years, then you’d end up with $929.

      I do, however, agree that dollar cost averaging works in the long-run but in this scenario it doesn’t. Furthermore, dollar cost averaging doesn’t work for every account that people have. The situation where I see this being the case is with 401(k) rollovers. Once somebody rolls it over into an IRA, they rarely add money to it again as they’re investing in other places. Therefore, for that particular account, dollar cost averaging would not be taking place.

  17. This reminds me of one of my personal sayings: You don’t buy groceries with percentage points, but dollars. Average percent returns aren’t useless–especially for comparison purposes–but in the end what really matters is how many dollars we accumulate, right? I think the charts provided by many (or maybe all?) mutual funds of the growth over a certain period of time of a hypothetical $10,000 (or whatever) investment give a clearer picture than does an average percent return over the same period.

    • Andy says:

      The question, Kurt (and one that I don’t know the answer to), do they base those charts on the average or actual performances? My guess is that they still base it on the average and therefore would be misleading.

      I do agree with you completely that the averages do work exceptionally well for comparison purposes!

  18. I don’t think it’s wrong at all. The averages are just that, averages. If you purchase when the market is up 15% for the year you are going to feel a lot worse than the average investor when it pulls back 10%. You’re going to be down 10% and the others who have been invested all year are still going to be up 5%. No one can time the market perfectly so that is why dollar cost averaging and diversification for the average investor is important. It helps reduce your risk.

  19. I hadn’t ever really thought about this but you make a great point. I don’t invest based on average historic returns though I invest in the future! Here is to hoping the future is good to us all with our investments!

    • Andy says:

      You don’t care what a fund has averaged over the course of the last 3, 5, 10, or 20 years? I may be in the minority, but that is absolutely something I consider when selecting my funds.

  20. I’d agree in that they’re not really misleading. I think if the media were to report numbers like you’re saying here that 50% of the people watching or listening would either simply not hear it or their heads would just be swimming. While I agree with you that it is the right way to report number as they are accurate, just don’t think many people would understand it.

    • Andy says:

      I think if people were subjected to it for long enough then they’d understand it. I just get annoyed when people pump the average like it’s what you actually would experience: for instance a person named Dave Ramsey comes to mind.

  21. I do think that the average rate of return statistics usually sound overly optimistic. I try not to worry too much about my investments though since we are so young. We are sooooo far away from retiring and needing them….but it’s hard not to get caught up in it.

    • Andy says:

      Holly, I’d encourage you not to overlook this aspect of your life. Average Joe can testify to this as well (since he used to be a financial advisor), but nearly EVERY retiree you talk to will tell you that they wish (1) they would have started saving earlier and (2) would have saved more earlier. So…just because you’re far away from retiring doesn’t mean it shouldn’t be one of your top priorities.

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