The next time you hear that the market has averaged 7% or 10% over the last so many years; you need to be wary about who is making the claim and how they are basing their assertion.
An average rate of, say, 7% is only an average of the rates of the past so many years divided by the number of years. If you were to apply the formula to your actual money, you will find quite another result if the market has been in a negative position at any stage during the period under review.
How is this so, I hear you ask? Well, let me explain by offering a real number scenario. Say you have $10 000 to invest and you put this into the market. Let us assume for simplicity that in year 1 the market goes up by 10%, and in year 2 it goes down by 10%. So far so good, and once again we have kept this simple. Now if you wanted to know the market average over the last 2 years the answer would be zero, right? 10% gain in year 1, followed by a 10% loss in year 2.
Now let’s have a look at how that affected your actual money. In year 1 you started with $10 000 and made a 10% gain which would mean that at the end of year 1 you would have $11 000 invested. Now in year 2, you take a loss of 10%, and your investment goes down by 10% of $11,000 which is $1,100 giving you $9,900 at the end of year 2.
So you are NOT back to square one which would have been $10 000 but are down $100 or 1%.
If we were to take the loss in year 1 and the gain in year 2, the result would be identical. This is because any loss requires more than the same percentage in any subsequent year to get back to the same amount of funds invested. If you take a loss of 20%, then you will need a gain of 25% to get back to where you were.
However, in a Fixed Index Annuity, ‘the average remains the average’ with no hidden loss because you never have a loss. The worst you can do in any year is to stay level, and this is the power of the Fixed Index Annuity because you never incur any losses and any gains are locked in on an annual basis after which you can never lose them.
So the next time you are quoted an average return, bear in mind that if the period in question contains a negative in any year, then the average is not what you would have earned per annum had you been invested in that product/market.
To learn more from this annuity professional, simply click here (Anton Hendler).
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