E80: How to Know When Rate of Return is Deceiving You

In this episode, we discuss how the rate of return numbers can be manipulated to deceive you into believing an investment is better than it is. We’ll also share how to protect yourself from predatory investments.

We’re going to dive into and focus on some things that we’ve seen happen to people across the investment landscape.

When looking at investments, it can be tricky because many people can manipulate these numbers to look much better than they are. These are myths some advisors use to deceive people. However, these aren’t exclusive to advisors. They’re used in many investment areas.

Rate of Return Topics Discussed:

  • Common investment myths perpetuated by some advisors
  • How to ask the simple yet revealing questions
  • Understanding the average rate of return vs rate of return
  • What to watch for in lending clubs and various real estate syndications
  • Knowing why no one will care more about your money than you will
  • Financial marketing myths
  • Watching out for portfolio sleight of hand

Episode Takeaways:

  • A big way to safeguard your money: ensure the person advising you has skin the same game they’re directing you towards.
  • Don’t believe the average rate of return of investments. There’s a big difference between an average rate of return and an actual rate of return–even in 401Ks. So just remember the average rate of return is not the actual rate of return.
  • Most of the time you only lose money when you give it to somebody that you thought they do better with than you could. What that means is you’re giving that control of your money over to somebody else, hoping that they can make it perform better than you could make it, but you don’t really ask enough questions.

Episode Resources:

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Podcast transcript for episode 80: Rate of Return is Deceiving You

Nate: In this episode we will discuss how rate of return numbers can be manipulated to deceive you into believing an investment is better than it really is. And then how to protect yourself from predatory investments. She’s Holly, and she helps people find financial freedom.

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

Nate: Everyone, thanks for coming back with us for another episode of Dollars and Nonsense. We’re always happy to have you here, and as I’ve mentioned before, it really helps get the word out if you guys would rate the podcast. Give us a great rating, share it on social media and various other things. It just really helps. Leave a review. Things like that really help get the word out. Especially if you’re enjoying the podcast, and we hope you are.

And if you have any ideas for a podcast, you can always reach out to Holly or me. Pretty simply, our emails are holly@livingwealth.com and nate@livingwealth.com. So feel free to email us if you have any ideas and want us to discuss something, we’d love to hear from you. With that being said, we’re going to dive in today to an episode that is really focused on some things that we’ve seen happen to some of our people we’ve spoken with, but we see it all across the investment landscape, and that is this rate of return number.

It’s an important number. It’s an important thing to discuss when looking at investments or places for money to go, but it can be tricky because many people can manipulate these numbers to look really good, but it can be very deceptive. So we’re going to talk about some myths out there, or some deceptions that are used by just normal investment advisors and investment builders, like in the real estate world, and the life settlement world, and the lending world, and all these people who are trying to get our money. They can trick us into thinking the investment’s going to be better than it really is. So keep your guard out. We’re going to dive into some of that today.

Holly: We’ve talked in the past about questions you should ask yourself when you’re going to invest. So go back and listen to some of those podcasts. But one of the biggest things is making sure that whoever you’re investing with, or in, that they also have, we like to say, some skin in the game. Are they putting their same money in the same place? If they want you to be investing in something that’s so amazing and wonderful and they’re not doing it, maybe ask herself why they’re not doing it. So just a little myth there. It’s not really a myth, just a question of educating yourself, and you only want to be doing something maybe somebody else is doing.

Nate: One of the biggest rate of return myths out there, is people love … Or deceptions. People love … I think we’ve talked about this on the podcast before, but people love to promote what’s called an average rate of return. You hear this all the time, like “Yeah, this investment has averaged 10% over the five years.” Whatever it is, or even a longer period of time. And so we think that is what we can expect to earn as we’re trying to pick and choose where to put our money. But we have to ask a further question because there’s actually a difference between an average rate of return, and an actual rate of return. And to paint a picture, if I could, I can show you what I mean by that.

So if we had invested $100,000 into an investment, and let’s say it increases by 50%. So at the end of the year you have $150,000, and you made a 50% rate of return. This is the best investment you could have made. It’s hit it out of the park. Then the next year it loses 50%. So we’ve had one year where we made 50%, we had another year where we lose 50%. We kind of think in our mind that we’re at a 0% average rate of return. If we made 50% and then lost 50%, we probably should be at an average of zero rate of return. But if we lose 50% on a $150,000, we’re not back where we started, we’re actually down at $75,000. That’s 50% of 150. So we’ve actually lost $25,000, even though we had both kind of thought off just looking at the numbers that we would be back at zero, back where we started. So the rate of return, the average rate of return, actually means nothing in a world where it’s possible to have a negative return somewhere in there. Because the negative returns throw everything off.

We’ve seen this happen before where people, they’ll paint a picture of an average rate of return that the stock market has made, or their mutual fund has made, or these various things. But then when we actually looked at their past performance and you run the numbers. If I had put in $100,000, and kept it there for the last five years, they say we averaged 10% return, but we actually only … We’re right back where we started or less, because of how the numbers actually work out. When you have losses in there, the average rate of return goes out the window, and you have to ask further questions and do further analysis to see what has this investment actually done over the last five years?

Holly: And I think Nate, it’s really telling to that even when you want to find out information on an investment, and even how something is performing, even if it’s your 401k or something like that, typically all they will ever give you is an average rate of return. And you have to actually ask for an actual rate of return. And even then sometimes you can’t even get the actual rate of return.

Nate: That’s what’s a little bit freaky. And so those are the things that are being advertised but they might not even be real. And you see this in the stock market all the time. This is the main thing. People will say, well the stock market has, over the last 30 years, has averaged X amount of percentage. But then you take into account the dotcom bubble. You take into account the 2008 crash. You take into count last year’s 20% deduction at the end of 2018, from October through Christmas Eve. It was just wreaking havoc in the markets. And you’re taking all these accounts, and you have a lot of people … And you might be one listening to this, who’ve been investing and don’t seem to be getting anywhere. Though you guys are seeing that the market is averaging a positive return. You think you should be making some good money, but you might actually look at your account and realize it’s not making a ton, because those losses impact your accounts more than the gains do.

As I just said, increasing 50% then decreasing 50% does not bring you back to zero. It brings you to -25%. Even though the average works out to be zero. There’s some deception, especially in the marketplace. It always matters when you got in and when you got out. And did you experience a real positive return on the money? Did you get all the money back? That does not happen every time. Even if you get an average that looks good, if it’s going to lose money, the averages go out the window.

Holly: So just remember average rate of return is not actual rate of return. So don’t let your ears be tickled with a number that you think is so amazing, when in reality it might not be. Just like Nate mentioned. Because I’ll be honest, so many people will say with the example Nate gave, “I didn’t lose any money.” I gained 50, I lost 50, when actually then they realize, “Oh I’m out $25,000 of what I put in.”

Nate: You see that in a lot in the investment, but even things like lending club and various real estate syndications that are out there, you can put money in and pool your money together to buy an apartment complex or things like that. You see this happen all the time where they’re showing estimated 18% internal rate of return, and all these sorts of things. And maybe it looks good on paper. We have so many clients who buy into those things, and I’m not saying they’re bad. I’ve actually had people who find a lot of success in those things. But on the flip side, I’ve also got clients who have bought in because it looked good on paper, so the track record was good, and they just happened to be stuck with investing in the apartment complex and this syndication that went south, and just didn’t work out very well. And they end up losing money and it’s just like a blindside loss. And that’s what I’m trying to say is, we can’t be so gullible just to believe the rates of return numbers.

They tickle our ear. We’re always looking for how to get the most return with the least amount of risk. That’s what we’re all after. So we’ll go buy into things that some guy is painting the picture of it being so good. And especially if you’re investing in something that you actually do not own the actual asset. If you don’t actually own the asset, and you’re literally putting your money into somebody else’s business and they’re going to pay you a return. This happens all the time, these things called merchant cash advances and some of these other investment holding style companies, where you just invest money into the company. They go invest money, and then you get trickled return as an owner of this entity. But the problem is you have no control over what’s going on there, and you see a crazy amount of these types of businesses actually have to file bankruptcy due to mismanagement.

It didn’t matter if the investments were bad or not. They could have been great investments, but the fact that you didn’t control what was going on caused you to lose money. My red alert comes up anytime someone pitches me an investment where I do not actually own the asset. I’m like some sort of shareholder in an LLC that goes and buys the asset, and it’s up to some other people to determine how to manage this asset and do things with it. That’s where you hear the most horror stories. So just keep the guard up. I’m not saying all of those are bad. Some of them are very good, but it’s certainly a more scary place to be.

Holly: I’m going to say something that Roy often says. Most of the time you only lose money when you put your money somewhere, or you give it to somebody that you thought they could do better with your money than you could do. What that means is you’re giving that control of your money over to somebody else, hoping that they can make it perform better than you could make it, but you don’t really ask enough questions because you believe everything that they’ve told you that this is what it’s going to do and be. And I think that leads us even to one of our next points is. Investment in advisors or individuals who are giving you a high rate of return on anything, whether it be a CD at 8%, whether it be this investment at 30%, yet they’re only giving you a small sample of how it’s performed over a period of time. Whether it be this last year or over the last three years it did this much, but if you look at five years before, maybe it was losing money.

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Nate: Rate of return numbers can be used to paint a picture that’s better than reality, especially in the world of stock market, or a hedge fund world, or things like that. I’ve had some investment advisors come in and they manage funds, and they want me to invest with them. And they say, “Nate, look at how well we’ve done this year.” And it’ll be 20% increase from January through June or something like that. This’ll be an amazing return. I’m like, “That’s really good.” But then you dig a little deeper and you find out the investment itself had lost 20% the previous year. So it makes it look good as far as this year, year to date looks good. But if you look at just over the year before to now, they’re just getting back close to where they were last year. So it’s like more of a rebound. It’s not actually creating any value. You lost so much and you’re just gaining ground back up.

What you always have to be concerned about is they’re picking the period of time, and the certain assets that they’re going to pitch to you are the ones that have done the best. And they can manipulate rate of return numbers to show you periods of time, or certain elements of the investment that have done really well, and try to pick and choose things to paint this amazing picture where it wouldn’t make any sense for you not to join. So you have to dig a bit deeper at times. So rate of return itself, it’s very important, but it can be so deceptive and it can be manipulated so easily, that you just had to keep your guard up. Just don’t go out and believe everything that’s said about these certain things because just because it was true in the past doesn’t mean it’s true in the future.

That’s another issue with a lot of people. They’ll say, “This guy’s averaged X amount over the past five years.” And they’ll say, “Well, I better jump in with this guy, or I might miss out on making a whole bunch of money, if I don’t invest with this guy.” The problem is that the best time to invest with that guy was five years ago. That’s when you should have gotten in. So whenever you see a great track record, that can be good, but that can also raise some concerns like how much further higher can this investment go?

But one more thing, I was just going to say really quick is that the syndication, like the real estate syndication, the commercial real estate syndications, those really took off 10 years ago and gained a lot of steam. And I’ve had some people come and pitch some to me to jump in and I’m thinking, “Yeah, I mean the numbers have looked good.” But the problem is they’re becoming so much more popular, that the time to get in … The door has shut on a lot of them. Because what happens is all the … These companies, they get started, they’re small, they don’t have a ton of investors. They’re very choosy which assets they invest in. Which especially in the corporate real estate world, or in the lending world, or some of these various other alternative investments. And even in the stock market, they’re very choosy with what they pick.

But when the more investors are pouring money in due to their marketing their rates of return, they got more money and they got to go buy more assets. But all those low hanging fruit, the really good properties, let’s say, that they were buying, they’re starting to reduce their standard a little bit because they got all this money from these investors saying, “Man, these guys are doing really well.” And so they’re buying properties that five years ago they wouldn’t buy, but they feel expected to buy these. So the returns start to go lower and lower, and they start taking more and more risk to be able to get it. So what I’m trying to say is these past performances, you have to take it with a grain of salt, because that does not mean anything for the future. Be wise about it, and determine if it is a valuable investment or not.

Holly: I and think too, a big key is don’t just look at how it’s performed right now. Like what Nate said, right now it might be performing really great, but you don’t know how it performed last year or two years ago or three years ago. So as much as we’re saying, be aware of it as well as … We say this a lot, do your own research. Don’t just believe what the person or the company is telling you how it’s going to perform. Ask them tough questions and find out for yourself information. Because oftentimes what you’re hearing is only what they want you to know. Not what is actually out there for you to research or find out. You might have to do a little research.

It might take a little bit of time, but if you want to make sure where you’re putting your money, it is a good rate of return or it is going to perform. You got to start doing your own research and asking yourself some tough questions of, are they just telling me what I want to hear? I think most of the time when you have somebody that’s pitching you something and it’s a good idea, you often have to come back and ask questions to make sure it’s the best fit for you and your money. Especially where you’re putting your money. I’m just going to tell you that. Nate and I both get a lot of, “Hey, you should do this.” From whether it be clients or individuals, “Pool your money here, or do this.” And oftentimes, once I start really looking at it, I’m not willing to take that risk.

Nate: Yeah. That first off, you need to make sure that what you’re investing in aligns with your purpose and your vision for your money, your game plan. I mean, rate of return is not the answer for everybody. If people are paying a high rate of return, you’re about to retire. You don’t need a high rate of return. What you need is more secure. You need to make sure that it won’t disappear. The return of your money is actually more important than the return on your money. There’s certain times that it might make sense for you to take more risk and be willing to go after it. There are other times that it doesn’t. So the rate of return can be manipulated. It can be deceptive. It’s a term that’s overused. It is a very important part of the piece. But if that’s all you’re looking at, you probably are going to sit yourself in a situation that could lose money.

That’s one of the reasons we do like infinite banking in these policies, is because we know contractually that we are going to earn money, and so it’s a little bit of a different world. It’s not a real investment, it’s life insurance policy. So there’s some differences to it. But we know it’s a real rate of return. There’s no way it can lose money. There’s no hidden manipulation of what’s going on. But these things have been around for forever, and have done the same things for forever.

So you can have a little bit more peace with that and it can help you feel more secure if you have the policy, and were using the policy to make some other investments, because now our money is guaranteed to continue to work for us the whole time. And we can just pick and choose the investments that we really think are going to produce a lot. We don’t feel this pressure to go invest because our … If you have idle money in a bank account or something like that, that’s not doing anything, you can feel pressure to put it to work, and make bad decisions. So just keep that in mind. Rate of return, it’s very important, but it can be very deceptive. It can be manipulated and don’t buy into something just because of the advertised rate of return.

Holly: And also don’t buy into something that if you don’t know a lot about it, or it’s something that doesn’t interest you, I wouldn’t recommend buying into something that you don’t really know a lot about or you don’t really have an interest in. Nate and I have said that a lot. You want to be able to invest in things that you have an interest in, and that align with your values or where you want to go. So just don’t be fooled in saying, “Oh, I need to do this now.” Maybe it already passed because you should have gotten in a long time ago, few years ago versus right now. So really evaluate those questions and ask, “Is this really what’s best for me? And is the same person going to be there longterm?”

Nate: My dad is an example. I didn’t get permission to talk about him, but hopefully he won’t mind. He’d been in the market, in this mutual fund from 1992 to 2012. So it was 20 years and he had … There’s a lot of good years involved in there. There’s some bad years involved in there. And the market had averaged, just the S&P 500 7, 8% maybe over that time, something like that. But his account itself, the actual return was less than 4%. I mean people hear this, market rate of return, how much it’s averaged. If you are in a mutual fund and your 401k, you don’t really know what it’s in, your IRA. You are just not going to get what the market is doing.Very few mutual funds ever produce what the market … And then when you include management fees and hidden fees involved with these retirement programs, and these mutual funds, your real actual take-home return is going to be significantly less. But these averages are used to sell it. And it’s a shame, but just because things have averaged, or just because even you’ve averaged a solid rate of return does not mean that the money’s actually doing what you think it’s doing, let alone that it’s going to continue. So be wise about the times, and be diligent with what you’re doing. But with that, we’ve pretty much ran out of time. This has been Dollars and Nonsense. If you follow the herd, you will be slaughtered.

Holly: For free transcripts and resources, please visit livingwealth.com/e80.