Investment Risk and the Growth of Wealth: The Importance of Course Corrections
I have a problem. In fact, I think we all have a problem:
We have been way too focused on returns, resulting in the utter destruction of our wealth.
The investment industry has been built using tools that might be appropriate for understanding investments, but are totally worthless for investors. In real life, real people, using real money do not care about returns. We care about our wealth, and the two are not the same. They are not the same!
Investing 101: Average is NOT Normal
On average, stock market returns are higher than inflation, money markets, or bonds. Understanding this is an important step to any successful financial plan, but there is a huge difference between "average annual" and "every year".
Many of the commonly-used approaches to financial planning take long-term average rates of return and then make the assumption that you will get that return every year. Say you build an investment portfolio that you think will have an average return of 8.5%. Just because the average is 8.5%, it should be obvious to anyone that has been alive the last 12 months that this does not mean we will get 8.5% every year.
While this may seem obvious, the implications are huge.
