AFW 1.1.4 — Investment Principles — #4: Deption of the Rate-of-Return

4. Deception of ROR¶

Average Rate-Of-Return and Volatility¶

Long-term average rates-of-return are important. However, if the rates-of-return are similar in two mutual funds, then the one with lower volatility may be a better choice, as it doesn't have to "work as hard" to maintain its average. Lower volatility also reduces the psychological stress of the client. (This concept applies to fees/annual expenses, as well.)

Fallacy of the Hypothetical¶

Please do not let the title of this principle mislead you. Hypotheticals are one of the most powerful tools you have in your arsenal. Often however, proponents of fixed-accounts will use a negative history to "demonstrate" that the stock market is volatile or doesn't perform well. This is wrong.

Start/End Date Deviation¶

When running a hypothetical, especially one that initially appears to have a low return, check the Start/End Date Deviation.

Looking at the first row of the above statistic one could infer that the ICA has been a poor investment for those 10 years (this is the worst 10-year perdiod ever for the ICA, by the way).

Not so fast...

That row only compares two days (Feb 28 1998, and Feb 28 2008) out 3,650 days! The other 3,648 days in between are ignored. (This is the fundamental problem of illustrations that are not rolling periods.)

Changing the Start/End dates by just seven months, improves the 10-year average by +6.84%, from -0.72% to 6.12%!

A Tool to Handle Objections¶

You can use this principle to handle objections. For example, if someone states that the last 10 years the market has been poor, your response could be...