Why 14% is Waaaay Better Than 40%

Why 14% is Waaaay Better Than 40%

This week I was planning to begin a series of columns discussing the “new” Roth Conversions that seemingly everyone in the personal finance industry is “crazy” about. Then I realized I had to clear up a distortion I have been noticing recently – especially this past week. So look for the Roth series to begin next week.

WHICH WOULD YOU PREFER YOUR INVESTMENTS TO RESEMBLE?

We all know that 2009 was a better year than 2008 when it came to investing in the stock market. But all of a sudden, certain financial advisors are now pointing investors to what their investments earned in 2009. Remember, these are the same who were not returning investors’ telephone calls when the market crashed in 2008, either because they were extremely busy, or perhaps because their voice mails were deleting the messages before they could listen to them.

I can think of two credible reasons why these advisors are trumpeting your 2009 returns:

1. To divert attention from the fact that because so many investors’ portfolios are still significantly down, they may now be questioning the validity of their advisors’ strategies.
2. These advisors are truly and completely clueless.

Personally, I’d vote for Number 1 because I cannot convince myself that any advisor could be this clueless.

Joseph’s story

In one particular case that I know of, Joseph’s investment advisor is tooting his horn and patting himself on the back because Joseph’s portfolio earned 40 percent in 2009. While I understand that plusses are good in investing, here is what’s bizarre about this advisor’s view:

In 2008 – just a year earlier – Joseph’s portfolio, which was managed by this very same genius advisor, took a 35 percent nosedive. WAIT!!!! Before you say that over the past two years, Joseph’s portfolio is then up by 5 percent (down 35 in 2008, but up 40 in 2009), let me show you something that millions are missing.

Actually, Joseph’s total return over those two years is NEGATIVE 9 percent! No, this isn’t the “new math,” but it does sound odd, so let me explain. Joseph’s portfolio was worth $100,000 at the beginning of 2008. He lost 35 percent that year, so he ended with $65,000 (his original $100,000, less 35 percent). He then gained 40 percent on the $65,000 (which totaled $26,000), meaning his ending balance was $91,000.

Now it’s clear that over those two years, Joseph’s value is still down 9 percent, compared to the $100,000 he began with in 2008. This math not only applies to Joseph’s portfolio, but it is applicable to every investment. When you lose 35 percent and then gain 40 percent, you net negative 9 percent. For Joseph – or any investor – to have broken even in 2009, his portfolio would have had to earn approximately 53.6 percent – which we all know did not happen.

I am still trying to understand Joseph’s advisor – and the scores of others just like him. In 2008, he advised Joseph to ignore the 35 percent loss, apparently because it was “just one year” and instead focus on the long term. In 2009, he is now advising Joseph to focus on the 40 percent gain and ignore the huge loss he experienced in 2008. Interesting, isn’t it? How quickly the rules change depending on whom they favor.

Marvin’s story

Marvin is one of my clients, and his results were dramatically different from Joseph’s.

In 2008, Marvin’s portfolio earned plus 6 percent, and he earned plus 14 percent in 2009. Before you conclude that 14 percent sucks compared to Joseph’s 40 percent, I’d encourage you to do the math first. Marvin also started with $100,000 at the beginning of 2008, and it increased to $106,000. Then in 2009, his $106,000 earned 14 percent, leaving him with an ending balance of $120,840.

It is EXTREMELY important that you also notice that Marvin’s investment is in a vehicle which, under US the tax code, he can access tax-free, even before he reaches age 59½; he can also transfer any remaining funds to his heirs, income-tax free!

In just two short years, Marvin has $29,840 more than Joseph (Marvin’s $120,840 versus Joseph’s $91,000). And remember that they both started with $100,000 at the beginning of 2008.

Whose investment strategy would you rather pursue?

Do you really want to pay attention to and make your investment decisions based on all the noise about returns, especially when they can be so distorted?

Can you now see how easily someone could have been led to believe that Joseph’s strategy must be better, and that he therefore must have a larger balance than Marvin, when in fact the exact opposite is true?

Perhaps you now understand why our investors are completely “crazy” about us.

Call us at (301) 949-4449 or visit our website to schedule your free, no-obligation consultation and let us explore whether you could get more bang for your bucks! Isn’t that the whole purpose of investing anyway?