Like many desert dwellers, I love a good beach vacation. I have always thought San Diego had perfect weather, unfortunately too many other people think that as well. I heard that the average year round temperature in San Diego is about 65 degrees. Considering that includes nights and winter, who wouldn't want to live in such a wonderful climate?
A friend told me this week there is another popular tourist destination that also boasts a similar average temperature.They call it Death Valley. Contrasting the Death Valley winters that fall below freezing to the summers that can surpass 130F, it is clear that "average" temperature means very little in real life. Though Death Valley makes for an interesting visit, very few would want to live there, regardless of the average temperature.
I learned in statistics class that "average" can have many different meanings and is only useful as a measuring tool if you know the specifics as to how it was derived. In investing we hear of "averages" all the time, the most common being the average rate of return. It is not uncommon for investors to compare average rates of return of various investments, then make decisions based on those numbers. But unless you know the details of how the average was obtained, you may be like the uninformed Death Valley camper who shows up on a day when the temperature is hitting 130 degrees. The much milder yearly average temperature will be of no use to that visitor.
In investing, average rates of return have value, but at least equally valuable is measuring the peaks and valleys that you have to endure to reach the average. I imagine that most investors would be thrilled to achieve an average rate of return of say, 10%, but if they had to go through some years of losing 50% along the way - much like the volatile weather in Death Valley - I suspect most would say "No thanks." We tend to view investing as a numbers game, as a mathematical formula from point A to point B, but it is really much more than that. Investing is about lifestyle and peace of mind. A investment that grows well over time may be of little use to most investors if along the way its peaks and valleys create too much emotional distress.
When people plan vacations, rather than look at the average annual weather for the area, they look at the expected weather for the particular time of year they plan on traveling. When you invest, don't just look at the average returns over the past 5 or 10 years, but rather evaluate how those returns were obtained, what were the peaks and valleys, how did it respond to various unexpected events, and what is the likelihood of the future performance mimicking the past?
Failure to consider the statistical traps that surround the concept of averages can result in the investment equivalent of driving your family to Death Valley in August expecting to find beautiful San Diego weather.
Hi, I'm Dan. I'm a CFP® Professional.
Securities and advisory services offered through Commonwealth Financial Network®.
Member www.finra.org / www.sipc.org , a Registered Investment Advisor. Wyson Financial, 1173 S. 250 W. Suite 505, St. George, UT 84770.
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