E6: Don’t be Deceived by Rate of Return

Nate: In this episode, we’re going to discuss why your focus on rate of return is actually prohibiting you from getting wealthy and even how those rate of return numbers are manipulated to keep you in the dark. So if you want to break free of the Wall Street mold, then you won’t want to miss this. She’s Holly, and she helps people find financial freedom.

Holly: He’s Nate, and he makes sense out of money. This is Dollars and Nonsense. If you follow the herd, you will be slaughtered. Episode 6.

Nate: Today we want to discuss something that’s pretty big to us. And it’s taking the world by storm. Everybody is infatuated with focusing on rate of return. I’ve seen it. Holly, you’ve seen it. But there’s a lot of issues when people get their mind so fixated on rate of return, and Wall Street knows that everyone’s fixated on it, so there’s a lot of deceptive practices that take place with this idea of rate of return. Now, Holly, whenever you hear someone say, “I made 10% last year” or “I made 10% every year for the last ten years.” What do you think they’re really referring to?

Holly: Nate, they’re actually referring to, most of the time, the average of their return, not the actual rate of return on the money. And the average is thrown out there often times because people hear a bigger number if you look at an average rate of return versus the actual number rate of return. And it is possible to get a zero percent actual rate of return, isn’t it, Nate?

Nate: Oh yeah, you’re exactly right. And what Holly is saying with the actual and average, everyone throws out that “my mutual fund made 10% over the past ten years” or something like that. But those numbers don’t mean anything. I hope people understand that. That it’s actually possible to say you’ve averaged 10% but lose money. And that’s what we want to help people understand today that when focused on rate of return people can actually—it’s not necessarily lying, but it’s deceiving because it doesn’t actually happen. In other words, if I had $100,000 and I earn 10% per ten years, I’d expect to be way above $100,000.

So I wanted to share an example of the average versus the actual rate of return and how you can earn a positive average return and think you’ve made money, but end up with less than you started with. In actuality, if you look back at a ten- year period of time from 1999 to 2008, over a ten-year time period, in the S&P 500 you actually had an average rate of return of .68%. So from 1999 to 2008, the average return was .68%; people would probably think, “Okay, I’m actually a little bit ahead of where I was ten years ago.” Even though during that timeframe, there was a couple of market crashes. But if you actually run it out, the actual rate of return was -1.34%. Or in other words, you ended up with less money than you started with, even though the mutual fund you’re in would have told you, “Hey you actually made, over the last ten years, .68%.” The actual dollars you have would be less than what you started with. Now, Holly, why is that?

Holly: Part of it is because there are all these fees associated with the market that people get paid. It also has to do with you are constantly losing money, even if you’ve put money in there, and one year, you may have gained 8%, but the next year it drops. What it never takes into account in the average is what it actually costs you to invest that money and what it costs to pay the individuals to do your work for you.

Nate: That’s true, but even in this example here, we didn’t even include the fees in there. With that rate of return that we just did. That would have made it even worse. You’re right with the fees and the mutual funds that make it even worse. But one of the principles behind it is that a down year bears more weight than an up year. And what I mean by that is say you had $100,000, and it was in the market, and you had a 20% return one year, so now that account balance is sitting on $120,000; it earned 20%. And if the next year the account went down by 20%, your average return is actually 0% isn’t it?

Holly: That is correct.

Nate: It went up 20% one year; it went down 20% the next year. So they would say you made an average of zero percent over the past two years. But you’re not actually back at $100,000 are you?

Holly: No.

Nate: Because $120,000, if you lose 20% of that, you’re actually down to $96,000 not $100,000. So even though over the two years your average return is zero, the actual amount of money you have left is only $96,000, even though you started with $100,000. And that’s the issue is when markets go down, a lot of times mutual funds and different people are looking at the average returns, they just add together all the returns for the last ten years and then divide by ten, and they get a number, and they say, “Okay, you’ve averaged this return.” But actually the average return is extremely misleading because, first off, if you have a down year, it carries more weight than the positive years do. And as Holly said, all their numbers are before fees in the first place, and nobody works for free. So you got to take out the fees on top of it. It’s very easy to have a positive average return, which is displayed, but actually end up losing money. And people don’t understand that. This is probably the first and biggest myth out there about rate of return. Rate of return is a very manipulative number, a deceptive number, because people can just kind of pull it out of their hat. With fees and down years… it’s crazy, isn’t it?

Holly: Nate, they often and almost always only say, “This is your average.” And real- life example: a client of mine had money in the stock market even this year, in January. And the stock market didn’t do real well in January. And his advisor said, “I don’t know why you’re going to pull money out because your average over the last”—because he’d had it in for around thirty years—“your average has been over 11%.” But actually he didn’t even have nearly 11% of the growth. And when it came down to what the actual number was, he was in the negatives more than he was in positives just because of 2008 and the market and the way it dips and flows. So he had actually lost more money, $100,000 he has lost, versus what he put in. And yet his rate of return was 11%. That’s what [the advisor] said; the average is 11%. And when you ask them, “Tell me what my actual rate of return is; can you show me each year what that is?” Often times even the stock market brokers and the individuals doing your investments will say, “Well, here’s your return.” And you see a real positive number, and people are being deceived even with their money market accounts, their CDs, and their mutual funds because they think they’re performing very well because what they get a report on is what the average has been or even what they’re shown in is if you put your money here in this mutual fund this is the average rate of return. And what’s wrong with that picture, Nate?

Nate: Well, with the average rate of return there are a lot of issues, like we’ve already said. It’s always before fees, and [it] doesn’t even include the impact of down year —any time you have a down year in your portfolio, if someone hands you an average rate of return report, you can just rip it up, because it doesn’t mean anything. But it also can’t even tell the future. So there are a lot of issues when someone says, “We’ve averaged 10% over the last ten years.” That actually shouldn’t mean anything to you. Because it won’t tell the future, it doesn’t tell how much fees are, and it doesn’t impact reality as we’ve shared with real-life example with the S&P 500 for over a ten-year period.

Holly: And they’re always going to give you an example that is the best example or the best paperwork they can show you. They’re not going to give you the worst. They’re going to run the numbers until they can give you the best average they can get in order to hook you into putting your money in there because we’ve all been taught over and over again, “What is the rate of return?” I get asked that question every day. Don’t you, Nate? What’s the best rate of return on my money?

Nate: Exactly. What’s my rate of return going to be? The issue, Holly, is that they’re comparing it to things that aren’t realistic. People hear rate of returns … and they just believe it. You need to do your due diligence. Whenever someone goes out and tells you something about an investment—it’s average this amount—people think okay then it’s going to be doing that forever. When it’s just not the case. In fact, it’s probably deceptive. Because as you know, exactly what you said Holly, everyone’s trying to show you a great picture of a return number to get you to invest with them, and now that everyone knows that the populace is so focused on rate they’ll manipulate the numbers and use deceiving measures to get you to invest with them, and most of the time it’s not true.

Nate: So what we’re going to do [is let] our sponsor Living Wealth give a quick note and we’ll be right back with a few more issues with rate of return and really what your mind should be focused on moving forward.

Nate: Welcome back. We’re talking about rate of return today. We’ve already talked about the difference between actual and average and how Wall Street has really been manipulating those numbers for years now. And it really shouldn’t be something you put your focus on. And what I wanted to start us off for this next portion is that the return of your money is much more important than the return on your money. And that’s what you should be going into life [thinking], and that’s one of the things Holly and I do, whenever we talk about the infinite banking process, is that our focus is not on rate; it’s on volume. We want to get you into the mindset of recapturing money that’s currently leaving. Everyone is out there trying to get as big of a rate of return as possible, and every time you go out and try to get that great rate of return you have to take risk. Well I can promise you there are probably ways that you can start recapturing things that are normally leaving—car payments, house payments, boat payments, credit cards. All this money that’s leaving you can bring it back in, and make a lot of money without having to go get a high rate of return on the investments that you’ve made.

Holly: And I think Nate made a really key point, too, that we are often taught that it’s rate of return versus the rate on your money. And really you have to change your mindset and understand it’s really not about a rate of return; it’s about volume … and what you’re actually putting your money into and where you’re putting it and who is getting your money and using your money versus you. And really we haven’t talked too much about volume as much as when you look at the volume of what you’re saving and you’re always concerned with you don’t have enough to live on later in life, the problem with that is that even if you save 10% of every dollar you make or 10 cents of every dollar that you make, more than 10 cents is going to the banks and Wall Street, and your mutual funds, and your IRAs. And all that money is being tied up. So even if you save 10 cents of every dollar you make, you’re giving more than that away to other individuals and institutions to make money. And that’s really where your average rate of return comes in. For average, they look at that because they get to use your money versus what is the volume that you are saving and able to invest, and with that volume, what can you recapture?

Nate: One of the things I like to think about is how Wal-Mart does their business. Wal-Mart wasn’t built on making a high rate of return every time they sold anything. In other words, if you think about it in terms of business, Wal-Mart has become the biggest company in the world; you look in the report of Forbes “50 most wealthy families in the U.S.” or something like that, and normally the richest person is either Warren Buffett or Bill Gates (they kind of move depending on how their business did that year, which one’s the richest, wealthiest). One of the things that I’ve heard a joke made of—is the only reason that Bill Gates is the richest person in the world is because Sam Walton died. What we mean by that is that as soon as he died, his estate was split up three or four ways and now his kids are always in the top. The Walton family, multiple kids, are in the top ten of the wealthiest people. If you combine that all under the one roof of Sam Walton, he’d be the wealthiest person. But he didn’t create what he created by focusing on rate, by trying to make a lot every time he made a sale. He tried to do it in volume. And they have the highest revenue of any company in the world. And that’s the thing: you ought to be focused on making a return on more of your dollars. That’s what infinite banking is all about, is earning money on more and more of your dollars. Dollars that you didn’t even think you could earn money on because you’re so used to sending it to the bank. Credit cards, car loans, mortgages, and things like that. It’s the Wal-Mart approach to becoming wealthy. You don’t have to earn a huge rate of return and take a lot of risk to become wealthy if you just learn to make a rate of return on a higher amount of the dollars that end up flowing through your pocket.

Holly: So Nate was talking about Wal-Mart and how Sam Walton really viewed it as not how much money he made off per item he sold, but how many items they could sell in a day, that volume of selling and restocking shelves. It’s the same way with your money. We really have to look at it as what is that volume and how can we recapture the money, the cash flow, that’s going out of our hands everyday to somebody else and bring it back to ourselves. And there’s many different ways to do it. But the one thing you really have to pay attention to is we’ve all been taught to go to a bank to borrow money and to pay that money back to the bank and really all of us have a rainy day fund to some extent. And what we do is take that money out of there with every intention of paying it back. And sometimes we do and sometimes we don’t. But when we pay it back, we only pay back what we took out. And really that’s doing you a disservice because you’re not doing what banks do with your money; you’re not recapturing that money. When you look at actual rate of return versus average, you really have to start understanding how your money’s working and how you can maximize the volume of your money versus just focusing on what’s my rate of return. Would you agree, Nate?

Nate: Yeah, I definitely agree. I think instead of everyone trying to go find a place to get the highest rate of return, people should really be focusing on getting a consistent rate of return on more money. In other words, instead of going out and taking a lot of risk and buying the IPO, tech IPO… most people are trying to put in as little to get as much back as they can, if that makes sense, Holly. In other words, I want to put in as little money into this, and because I’m only putting in a little bit, I’ve got to get a huge rate of return in order to make it happen. So then they go out and take all this risk, and then they’re wondering why twenty years later, they’ve lost money. Or they haven’t done as good as they thought they could. And that’s one of the things, Holly, we’re talking about recapturing, is we would rather make a rate of return—if you really take a look at it, and this is the average, the average person spends 40-50% of their income in payments to the bank. Most of that going to interest. For cars, houses, and credit cards. Just think of all those payments you’re making, you could put to work elsewhere and earn a rate of return on those. It doesn’t have to be high anymore because you have a lot more money working for you, like the Sam Walton approach. Just have more money working for you and figure out ways to use it. I’m in total agreement there. It’s not about the rate; it’s about the volume. I don’t need to get a huge rate of return because I’m the banker and I’m recapturing what most people are sending out and making money on it. And that’s huge. I think, Holly, we’ve mentioned [it] a little bit but another issue with the rate of return phenomenon is that people are always out there and their advisors are selling them these great rates of return: 8, 10, 12, 15% even. Dave Ramsey is a big proponent of earning 12%. Now, if you think that your account is going to be growing at 12% every year from now until the day you die, and it doesn’t actually pan out that way, you’re going to be in a world of hurt because you’re going to think you’ll have more money than you do, and when it comes, you’re not going to have enough.

Holly: Yeah, really what happens is we’ve been taught to look at the picture, and there’s really small print down below, but really what we are presented is the ideal situation for you to able to retire. What you see and what you’re given is that 12%, that magical number, and everyone has a magical number, and we’re given that number and we think, “If only that’s what our money is going to make, then we’re good.” And what we don’t often see is we don’t have 12% every year. And then you go to retire—and I’m going to bring it back to Wal-Mart— but that’s why you see more and more older people going back to work. Because what they thought that rate of return was and would be enough for them isn’t once they retire.

Nate: All roads lead back to Wal-Mart. That’s exactly right. If you think you’re going to earn 12%, then the guy’s going to tell you only need to put in X amount of dollars to get to where you need to be. But if you’re only putting in $1000 a month and you expect to earn 12%, but you only earn 6%, which is more realistic or less than that, then you’re going to think at the end of the day you have twice as much money as you really do and try to retire on half of what you had expected to have. That’s going to be hard. That’s where people find themselves.

Holly: And they see that 12% and they don’t see all the costs associated with that; they only see the return of 12%, Nate. And we’ve talked about the hidden fees of what is going to fees, what are you paying just to have that account and to have access to it? So that 12% doesn’t take into account at all what you are actually making and what’s going to be used to pay someone else to process your request.

Nate: And the taxes. You got to pay taxes on them.

Holly: And the taxes alone. Some people end up paying more in fees than they do in their taxes.

Nate: And add those two together and you’re getting a butt whooping.

Holly: And your 12%, the maybe actually […] say it’s an average of 6% and then you’ve got taxes on top of that and fees. What is your rate of return really, Nate?

Nate: The average person is 2% or 3% after you throw all that in there. That’s what people are getting. And they’re thinking Dave Ramsey is right at 12%. It’s just a shame that we’ve been tricked into this deceptive nature of rate of return. That’s why we’re such big fans of infinite banking because you get a guaranteed cash value that never is going to go down, and we’ve learned, it’s simply a lifestyle principle of how to make money out of every single dollar that flows through your hands. So you don’t have to go trust in a 12% rate of return in order to make it. You’re just making a whole bunch of money off yourself.

Holly: Even if it’s only a 4%. You hear that 4%. You missed something Nate said that’s key: he said if you can take 40-50% of the cash flowing through your hand that you’re being paid, and you’re not giving it to someone else, you’re giving it back to yourself, that 4% on 40 or 50% on what you’re making, is way more significant—that’s the volume we’re talking about—than what that rate of return is. What you really need to look at is how much cash value, how much income am I going to have, after I start changing where my money goes?

Nate: I’d much rather be earning 4-5% on 40% of my income by recapturing all of the payments I’m making to the banks than I would trying and failing to make 12% on 10% of my income that I’m saving. That’s what Holly alluded to there. That’s one of the things we like about using life insurance policies because it’s not really built on a rate of return. Rate of returns are deceptive, and people can manipulate those numbers. But inside of a participating whole life insurance policy, you don’t have a guaranteed rate of return necessarily; it’s actually a guaranteed cash value. So you look at 30 or 40 years down the road, they didn’t guarantee a rate of return; they guaranteed how much money you would have. So that means, at the end of the day, as interest rates go up and down, it won’t impact you really at all. They can’t change the fees on you. They can’t change anything. It’s simply after 4 years, we’d know at least, how much we’re going to have guaranteed—money, actual dollars. And that’s one of the things I wanted to mention before we head out, the last thing I want to talk about. There’s people out there, especially in the life insurance industry itself, we know it Holly, we’ve had clients get talked to about universal life and variable life and index, and they’re always talking this rate of return or maybe even a guaranteed rate of return on these complicated policies—but what I want mention to people is just because they guarantee a rate of return doesn’t mean you’re going to make any money. Just like in the stock market world. If you have a universal life policy, they say you’re going to earn 3% on the cash value, that doesn’t actually mean that the account is going to grow by 3%. That actually just means that before they take out all their fees, they promise the account’s going to earn at least that. They are allowed to take out more in fees than what they credit your account. That’s why I tell people, a 3% rate of return on zero dollars is still zero dollars. They can guarantee the 3% all day long; they just don’t have to guarantee how much money you’ll end up having. That’s why you don’t want to go into one of those types policies. You want a policy that guarantees how much money you’ll have in the future. Not a rate of return because, as we’ve been trying to discuss, that’s very deceptive.

Holly: And what Nate said is really key there. They can charge you fees monthly, even if you’re not paying monthly in. Money is coming out of your account in those policies on a monthly basis as they see fit. And they can take the fees out. And you’re losing money everyday. And it’s really sad that you actually don’t understand that what they’ve given you, even as an example of how it could perform, are numbers that are not realistic numbers because they don’t show all those fees coming out—now you get a report at the end of year, but they don’t show you this month this much money is coming out of your account, and it didn’t go to anything other than paying for fees or services rendered.

Nate: And that’s why we’re such huge proponents of volume over rate. Make more money by increasing how much money you’ve got coming back to you. Don’t go out and try to get the highest rate and put in as little into the game as you can. Learn to be able to put more in by the process of banking and recapturing, as we teach. And if you don’t understand what infinite banking is all about, you can go to LivingWealth.com to find it, that’s our sponsor website. So it’s not about the rate; it’s about the volume. How much money do you have working for you and how much is that bringing in? Just because someone has given you an average rate of return doesn’t mean that’s what is actually going on. In fact, you can have a positive average but actually lose money. Just like we showed from 1999 to 2008 over ten years. And the best place that you can be is to have a guaranteed cash value, guaranteed amount of money in the future, that somebody else is contractually obligated to give you. Not a guaranteed rate because as we’ve been discussing they can deceive and manipulate those numbers like crazy. Focus on the Wal-Mart approach, not the next tech IPO approach. Holly, any last words before we close out?

Holly: I just want to end, too, with saying really think about the fact that you can take 40-50% of what you’re giving to someone else and bring it back to yourself and your family. And that 40-50% at even a 3% rate of return is better than 10% or 5% at 12% rate of return average. So start changing your mindset and thinking about how much money can I bring back to myself to recapture and look at that volume you can recapture versus that rate of return.

Nate: That’s the best thing to end on. That further said, this has been Dollars and Nonsense. If you follow the herd, you will get slaughtered.

Holly: Get free resources and transcripts from this episode by visiting livingwealth.com/e6.