Compound Annual Growth Rate – Just The Facts

In steps the Stock Market, assuring higher returns than stodgy old bonds, and money market accounts; for this reason, the stock exchange became the destination of selection for retirement savings and Wall Street reacted by increasing the proceedings to retail customers through Mutual Funds. Prior to the year 2000 it was not uncommon to hear that the S&P returned 16 % over the previous 10 years. Taking a look at the returns for among the very best understood indexed mutual funds, the Vanguard 500, returns considering that its 1976 beginning are 11.75 %, outstanding till you look at the 1 year return, -2.41 %, the 5 year return, 11.89 % and the 10 year return 5.06 %. These are average returns not genuine returns. As an example, let’s take a look at the growth of 1 dollar in the mythological High Fly Fund. High Fly posts a 50 % gain in one year and your dollar grows to $1.50. The next year it is publishing a 25 % loss, now your investment is worth $1.125. The average return for High Fly reported by the mutual business is 12.5 %, but that is not your actual return. Your actual return or compound annual growth rate (CAGR) is in the community of 6 % per year worse if you consider inflation.

Is 6 % appropriate offered the risk that investors take on by purchasing the stock exchange? David F. Swenson, CIO of the Yale Endowment describes investor risk in his book, Unconventional Success, when he states: ‘Because equity owners get paid after corporations satisfy all other plaintiffs, equity ownership represents a residual interest. As such, investors occupy a riskier position than, state, business lenders who enjoy a superior position in a business’s capital structure.’ He marches on to say ‘the 5.0 percentage point difference in between stock and bond returns represents the historic risk premium, specified as the go back to equity holders for accepting risk above the level inherent in bond financial investments.’ Mr. Swenson’s remarks and computations of the risk premium were based upon a compound annual return of 10.4 % in the stock exchange compared to 5 % bond yields. 10.4 %, -5 % equates to a risk premium of 5.4 %. I have yet to discover a computation of CAGR (compound annual growth rate) that matches Mr. Swenson’s. I discovered many examples of average returns that match the 10.4 % average growth rate however not the CAGR. The factor that this is necessary is that all other savings vehicles are priced quote by the CAGR. Your savings accounts, bonds and money market account are all estimated by the CAGR or its equivalent, the annual portion yield (APY). In order to identify where to assign your funds, you have to compare apples to apples not apples to oranges. As you might guess the CAGR for the stock market is lower.

It ought to be clear from these numbers that your returns are dependent not only on how long you are invested in the marketplaces but when you began investing. In truth the stodgy old bond investor has outshined the stock investor over the past 7 years.

And, on another note…

Mr. Swenson’s book is a must check out for anybody investing in mutual funds, he makes a convincing case, explaining why actively handled mutual funds are normally a money losing proposition for investors and why a balanced portfolio based upon 6 strong asset classes constitutes the winning mix for investors.

This Could Lead To Other Ideas

When assessing mutual fund returns, smart investors will look for answers to such questions. Prior to entering the nuts and bolts of mutual fund returns, it is good to understand exactly what the information reported in the financial daily really mean.

It can only be used for retirement 30 years. Other needs have to be paid for from an additional source aside from retirement savings. The majority of people does not have the financial education to comprehend this and blindly chase market returns wishing for a big score.

Thankfully, there is a simple option, however, like the majority of simple options, this one requires work and monetary education. I will certainly present this simple option in part 3 of this series.