Risk & Allocation
Nobody receives the average return
Long-run average figures describe a smooth line no investor has ever experienced. What you get depends on the order the years arrive in.
What follows is an argument about average returns versus real paths, and about where the received version of it stops being true.
The argument in brief
- Arithmetic and compound averages differ, and the gap widens with volatility.
- Your money-weighted return differs from the fund's published figure.
- A plan that only works on the average has no margin.
Averages hide the path
A long-run average return describes the outcome of an entire period compressed into a single convenient number. No individual year resembles that number, and the spread of individual years is far wider than the average implies. An investor experiences the sequence rather than the summary, and the sequence decides how a plan feels and whether it survives.
The average is a useful planning input and a genuinely poor description of anybody's actual experience. Presenting it without the range around it is one of the more misleading conventions in financial communication.
Arithmetic and compound averages differ
The arithmetic average of annual returns is higher than the compound rate actually achieved over the same period. The gap widens with volatility, because a loss and an equal-sized gain do not return you to where you started. Quoting the arithmetic average therefore overstates what an investor would genuinely have ended up holding.
The compound figure is the one describing an actual outcome, and it is the one worth using in any plan. Where a document does not say which of the two it is quoting, that is worth noticing before drawing conclusions.
Contributions change the number that matters
An investor contributing monthly experiences a return weighted by when their money was actually in the market. That money-weighted figure can differ substantially from the fund's published time-weighted return over the same stretch. Contributions made during weak periods buy more units, which improves the personal outcome relative to the headline figure.
Put simply, the reverse applies to anybody withdrawing, which is why drawdown deserves separate treatment from accumulation. Comparing your own outcome against a published fund return is therefore comparing two genuinely different measurements.
Why long-run figures get quoted anyway
Long periods are used because short ones are dominated by noise and can support very nearly any conclusion. The longer the period, the more stable the average becomes and the less relevant it is to any individual horizon.
The useful part is this: most people invest across a few decades, long enough for the average to matter and short enough for sequence to dominate. Historical averages also come from a particular set of markets across a particular era, which limits how far they generalise.
Survivorship in the historical record is a real issue, because the markets with the longest continuous data are the ones that did not fail.
Planning with ranges instead
A plan built on a single expected return produces a single answer and a thoroughly false sense of precision. Thinking in ranges makes a plan robust to outcomes that are entirely ordinary rather than catastrophic. The useful question is what happens to the goal under a poor sequence, not what happens under the average one.
Where a plan only works under the average, it is a plan carrying no margin whatsoever. Building in flexibility about timing or amount is worth considerably more than refining the expected return assumption.
None of this is a substitute for talking to a clinician if something feels wrong.
What to take from historical figures
Use them for orders of magnitude and for the relative behaviour of asset types, never as forecasts of anything. Treat any specific projected number in marketing material as an illustration of arithmetic rather than as information. Nobody knows what the coming decades will produce, and confident statements to the contrary deserve heavy discounting.
In practice, the variables you control are contributions, costs and whether you keep holding, none of which need a forecast. Those three do not require anybody to be right about the future, which is why they deserve more attention than the one that does.
The takeaway
The average is a summary of a period. You will live through the order the years actually came in.
Small and repeatable beats ambitious and abandoned, almost every time.
Questions readers ask
Why does my return differ from the fund's published return?
The fund reports a time-weighted figure. Yours is money-weighted, reflecting when your contributions actually went in. Both are correct measurements of different things.
Can I plan using a long-run average?
As an order of magnitude, yes. A plan that only works if the average shows up on schedule has no margin for an ordinary bad sequence.
