Monday, January 25, 2010

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.


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?


  1. Yes, it is all about perception, and using statistic to lie to people or at least convince them that You made right decisions, so they should continue to trust YOU, and not think what is really going on.
    So say in one willage of 101 people one got some bad disease and die.
    Doctor report deadly disease: mortality is 100%!
    But, there is vaccine for such disease, so doctor order 100 doses and vaccinate everyone. From adverse reactions to vaccine die 40 people, and doctor report big sucess: mortality rate is down to 40% after vaccination, therefore he reccommend that everybody has to be preventively vaccinated, in a country of 1 million people.
    200 000 people dies from getting that same disease or from adverse reaction to vaccine, and Hurrah! country was saved from pending epidemy and mortality lowered to just 20%, another big triumph for science of Medicine!

  2. Ah, Yes, but You also are playing Statistic game as it fit Your perception, as crisis of Wall Street pointed clearly big weakness of system as a whole, as system that would use money instead of Bonds and Shares could not lose walue at all!
    Therefore, if investors would invest money directly into companies, and get exact percentage of profit that company has earned, together with everyone else who invested their money. That would be the way to preclude manipulations with real value of some company whose value is in present system perceived as rising when people buy shares disproportionaly to actual rise in value because of new investment.
    So let's say one company decide to sell 40% of shares on market. Till then, let's say that value of one share was 100$, and they were sold for 200$ per share.
    It is perceived as 100% rise of value of shares, right? But if 100% of shares was worth 10 000$ before sale was made and price difference is just 4 000$, then now value of one share is 140$, so actuall rise in shares value on level of company is just 40%, right?
    After this, somebody who want to manipulate with shareholders offer to buy remaining shares for 140$, buying first from his companion shares paid 200$ for this price, spreading rumor that some iregularity has been found or that company would face financial problems, and presto, people who do not know what is going on see that value of their shares is down by 30% and start selling their shares fast, in order to not lose money, so manipulator get 100% of shares for their value like it were at start, once invested 4 000 is deducted from transaction. In worse cases buying price is dropped much more, and then manipulator get some profit in process, and then company suddenly >>recover<< and perceived market value of shares went back to 200$, for which value it would be sold or higher, because of proclaimed 30% gain in value of company....
    That is not possible in a system that uses money invested as measure of company worth, and anybody who would withdraw their money should be given proportional part of profit company earned in that period, or if profit is accounted at end of year, then they get their share of profit at end of year, but in no case they can get less then money they invested........
    In such system it is not possible to make investors think they would profit more if some factory belonging to company is closed, and if workers invest their own money in company they work for, then they would fast locate real problem in such factory and reprogram its production, introduce new and inovated products or do whatever is necesary for factory to continue bringing profit, as it also means livehood for them. Workers would easyly agree to get no profit at all in period neded for factory to adjust production, because they could still have their salaries. Shareholders would start selling shares if thex receive no profit, and that could put down perceived value of company to zero, while it is not so.......

  3. Anonymous,
    thanks for reading and for your comments. While I cannot fully comprehend your analyses, you seem to have completely missed the strategy we craft for our clients. They DO NOT play the direct stock market game.

  4. Thanks for sharing this simple blog. It is great! I'll definitely follow this blog

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