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Average ROR vs. Real ROR

    The following is for illustrative purposes only, the returns used are not possible and are only used to illustrate a concept.

    Average does not mean the exact same thing as real. I have a friend that says that he and his wife average about 50 miles a week riding their bikes. When you first hear this you would think that they both ride together about 50 miles. The real story is that she rides about 100 miles a week and he lays on the couch but between the two of them they average 50 miles a week.

    Funny story but the same problem can arise when talking about average rates of return over time versus real rates of return over time. Would you like to make and investment that averaged 25% return over two years? Sure, who wouldn’t. Suppose you invested $100,000 and earned a 100% return in year one. You would now have $200,000. In year two let’s say you lost 50%. Now you only have $100,000. You averaged 25% a year but your real return was zero.

    Suppose you started with a $100,000 and earned 100% the first year. Now you have $200,000. In year two you lost 60%. Now you only have $80,000. Your average rate of return was 20% but your real return was -20%. Don’t get fooled with averages, focus on the real or actual rate of return potential.