Investment returns can be deceiving, and stock brokers and mutual fund companies (along with the agents that represent them) often don’t much to bring clarity to the issue. When your investment broker tells you he can earn you 10% a year, there are two other questions you want to ask him before you sign on the dotted line:

1. Is that “net return” or “gross return”? Brokers love gross numbers because it doesn’t show you what the costs of doing business are. The reality is that transaction costs and fees can be substantial depending on your investment. For most mutual funds expect anywhere from 1%-2% in fees (unless you are investing in low-load mutual funds, which can sometimes be cheaper). A 10% gross figure means you will probably average 8-9% long-term. Most brokers wished they were that good. Sadly, many mutual funds under-perform the market. So, if you are earning 8%, your net could really be 6%.
2. What is the time horizon for these returns? In other words, does your broker think he (or she) can average 10% over the next 5 years? 10 years? 20 years? The time frame makes a HUGE difference in how realistic your broker is being with you.

During a time horizon of 10 years, a 10% rate of return – gross or net – is normally not realistic. Over 20 years, your odds increase. Why? Well, consider your odds of hitting a 0% or negative returns over the short-term. The day to day movements in the stock market are almost completely random. Trying to predict stock prices day to day is like trying to predict where the roulette ball will land next.

The shorter the time horizon, the more uncertain your gains (or losses) are. Typically, if you are diversified accordingly, a reasonable 10 year return is about 6.5% net after fees. The longer you stretch out the time horizon, the more certainty you gain about your average investment returns, but this doesn’t necessarily translate into certainty about the actual compound growth you’ll receive.

Conversely, if your broker is recommending you invest in a “hot” sector right now, perhaps you should think twice before handing over any of your money. An industry that grows 30% this year may level off next year or crash. What you end up with in 5 years could be a big disappointment.

I’m not easily swayed by a “hot story” or exceptional sounding investment returns and neither should you. As you can see, there are a few things that can make a good-sounding investment sound terrible in the end.

You might also like

1. The Honest Rate of Returns & Indexed Annuities
2. The Truth About Investment Risk (and why you can’t REALLY measure it)

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This entry was posted on January 4th, 2012 by David C Lewis, RFC. Edits may have been made to keep this entry current. · No Comments · Investing