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Chapter 2.3: Myth 3: “Our Returns? What You See Is What You Get”
In a Fox Business article titled “Solving the Myth of Rate of Return,” Erik Krom explains how this
discrepancy applies to the real world: “Another way to look at it is to review the Dow Jones since
1930. If you add up every number and divide it by 81 years, the return ‘averages’ 6.31%;
however, if you do the math, you get an ‘actual’ return of 4.31%. Why is this so important? If you
invested $1,000 back in 1930 at 6.31%, you would have $142,000, at 4.31% you would only have
THE SCALES ARE WEIGHTED
Now that we see that average returns aren’t a true representation of what we earn, sit back and relax
because the grand illusion isn’t over yet. The math magicians on Wall Street have managed to
calculate their returns to look even better. How so?
In short, when the mutual fund advertises a specific return, it’s not, as Jack Bogle says, “the return
you actually earn.” Why? Because the returns you see in the brochure are known as time-weighted
returns. Sounds complicated, but it’s not. (However, feel free to use that to look brilliant at your next
The mutual fund manager says if we have $1 at the beginning of the year and $1.20 at the end of the
year, we are up 20%. “Fire up the marketing department and take out those full-page ads!” But in
reality, investors rarely have all their money in the fund at the beginning of the year. We typically
make contributions throughout the year—that is, out of every paycheck into our 401(k). And if we
contribute more during times of the year when the fund is performing well (a common theme, we
learned, as investors chase performance) and less during times when it’s not performing, we are
going to have a much different return from what is advertised. So if we were to sit down at the end of
the year and take into account the “real world” of making ongoing contributions and withdrawals, we
would find out how much we really made (or lost). And this real-world approach is called the
dollar-weighted return. Dollar-weighted returns are what we actually get to keep whereas timeweighted returns are what fund managers use to fuel advertising.
Jack Bogle has been a continual proponent of changing this rule. He believes that investors should
see how much they actually earned (or lost) based on their own personal situation (contributions and
withdrawals included). Sounds like common sense, right? But it’s no surprise why mutual funds are
resistant. Bogle says: “We’ve compared returns earned by mutual fund investors—dollar-weighted
returns—with the returns earned by the fund themselves, or time-weighted returns, and the investors
seem to lag the fund themselves by three percent per year.” Wow! So if the fund advertises a 6%
return, its investors achieved closer to 3%.
THE TRUTH AND THE SOLUTION
Average returns are like profile photos for online dating. They paint a better portrait than the reality!
If you know the amount you started with in your investment and you know how much you have now,
(www.moneychimp.com/calculator/discount_rate_calculator.htm), and it will show you exactly what
the actual return is on your money over that period of time.
You must also remember that the returns reported by mutual funds are based on a theoretical person
who invested all his money on Day 1. This just isn’t true for most so we can’t delude ourselves into
believing that the glossy brochure returns are the same as what we have actually received in our
THE PATH IS CLEAR
Nobody said climbing a mountain would be easy. But it’s a heck of a lot easier when you have a
machete called “truth” to hack away the lies and grant a clear view of the path ahead. As an insider,
you are no longer flying blind.
You now know that stock-picking mutual funds don’t beat the market over any sustained period
(especially after you account for fees and taxes).
You also know that fees do matter. And that by lowering your fees, you can get back as much as
60% to 70% of your future potential nest egg. How will this awesome truth impact your future?
And finally, you know that average returns don’t paint the real picture. Actual returns matter. And
you now have the simple tools to calculate them.
Your journey to financial freedom has more than begun. You are hitting your stride, and the truths you
have learned so far will separate you from being one of the “sheeple.”
As I have taught people these tools, I often notice that people feel as though they can no longer trust
anyone. In a sense, they feel betrayed, as they become enlightened and start to understand the real
rules of the game. They think they must now handle everything on their own and become an island
unto themselves because “nobody can be trusted.” This just isn’t true. There are a number of
incredible financial professionals who are full of integrity and committed to their clients’ futures. I
have an amazing advisor whom I trust implicitly to act in my best interests, and together we review
and manage my investments. Like you, I am insanely busy and don’t have the time or desire to spend
my days managing the details of my portfolio. In reality, if done properly, a brief quarterly or twicea-year review is all that is needed to go over your objectives and rebalance the portfolio.
So how do you know the difference between a salesman and a trusted advisor? Between a broker
and a guide? Myth 4 will help us quickly determine if the person on the other side of the desk is
working for you or the name on their company’s letterhead. As “Deep Throat” from the Watergate
“Follow the money. Always follow the money.”
MYTH 4: “I’M YOUR BROKER, AND I’M HERE TO HELP”
“It is difficult to get a man to understand something, when his salary depends on his not
LET ME GET THIS STRAIGHT
So let us recap:
The mutual funds sold to me are charging me astronomical fees that could strip me of up to 70% of
my future nest egg.
Over any sustained period of time, 96% of actively managed mutual funds are underperforming the
market (or their benchmarks).
I am being charged 10 to 30 times what it would cost me to own a low-cost index fund and
“become,” or mimic, the market.
The returns the mutual funds are selling are typically way better than the returns I actually receive
since they are marketed as time-weighted returns, not dollar-weighted returns. Dollar-weighted
returns are what we actually get to keep/spend, whereas time-weighted returns are what fund
managers use to fuel advertising.
And as the grand finale, your broker will look you in the eye and tell you that he has your best
interests at heart. Because more than likely, he sincerely believes he is helping you. He doesn’t
understand, nor has he even been educated about the impact of what we described above. Heck, he is
probably following the same advice he is giving you for his own personal finances.
How in the world can the vast majority of Americans be dying the death of a thousand cuts but not
rise up, vote with their pocketbooks, and take their hard-earned money elsewhere? The answer is,
they’ve been kept in the dark for decades. Most people I talk to are highly suspicious of the financial
services industry as a whole and its desire to “help” you succeed. They’ve been burned before. Yet in
the face of a constant barrage of conflicting information and marketing hype, they quickly become
overwhelmed. Not to mention the demands of daily life. Many have put their financial lives on
autopilot and have accepted being part of the herd. “Hope” has become their strategy.
There’s a social comfort in knowing that you’re not alone. It reminds me of watching the Discovery
Channel and the wildebeest that cautiously approaches the crocodile-infested water for a drink just
minutes after the jaws of a croc clamped down on his buddy! Is the animal stupid? No! The animal
knows that without water it will die in the blistering African sun so it takes a calculated risk. Most of
us feel the same way. We know we can’t sit on the sidelines, on the edge of the riverbank, because
inflation will destroy us if we just sit on our cash. So, alongside our neighbors and colleagues, we
journey down to the water with trepidation, and when we least expect it: chomp!
A Black Monday. A dot-com bubble. Another 2008.
All the while, the brokerage firm with which we entrusted our family’s quality of life is taking no
risk and reaping record compensation year after year.
As I write this in early 2014, the market prices have continued to grow. From 2009 through the end
of 2013, the market was up 131% (including dividend reinvestment). That’s the fifth largest bull
market in history. People are seeing their account balances rise and are getting comfortable again.
Mutual fund managers and executives are raking it in. But the crocs are still feeding.
PROTECTION FROM WHOM?
In late 2009 Representatives Barney Frank and Chris Dodd submitted proposed regulation called the
“Dodd-Frank Wall Street Reform and Consumer Protection Act. One year later, after intense lobbying
by the financial services community, a version of the bill passed with far less teeth than the original.
But nobody stopped to ask the obvious question: From whom or what exactly do we need
From the people we trust to manage our financial future? From the brokers who sell us expensive
mutual funds? From the managers themselves, who play legal but shady games to line their pockets?
From the high-frequency traders who are “front running” the market and pinching millions one penny
at a time? In the last couple years alone, we have seen rogue traders cause billions in losses for
banks; large firms such as MF Global misappropriate client funds and ultimately declare bankruptcy;
insider trading convictions from one of the world’s largest hedge funds; and bank traders criminally
prosecuted for rigging LIBOR (London Interbank Offered Rates), the world’s most widely used
benchmark for short-term interest rates.