Do you understand the difference between an average rate of return on an investment and the real rate of return? Money masters do. So do financial advisors. Unfortunately, many of them don't want to share that knowledge with us, their customers.
Calculating and expressing the rate of return on investments is an area in which Wall Street wizards routinely perform the same kind of sleight of hand tricks we might expect to see at a top-notch magic show.
When David Copperfield mesmerizes us by making an object disappear and reappear right before our eyes, some degree of diversion is usually involved. When your financial advisor enthusiastically recommends a particular mutual fund and announces that it has a 20 percent average rate of return, he's also using a diversionary tactic.
In both cases, the trick usually works. Why? Because we want to believe. Deep inside, most of us really don't want to know how skilled magicians accomplish their tricks because it's more fun to believe it's really magic.
The same isn't true of your broker's sleight of hand. Learning how the trick is done can prevent you from making uninformed and potentially expensive investment decisions.
Rate of return—also referred to as return on investment, or ROI—is expressed as a percentage of the total amount invested, and it is usually calculated annually. There are several ways to calculate it, but the most typical way is by measuring the average annual rate of return. However, it's important to ...