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What’s Average?

What’s Average?

March 06, 2019

Recently, a friend of mine complained about all the rain we’ve been getting this year.  According to him, it’s not normal; we’re getting way more rain than Atlanta should. I asked him what amount of rain we’re supposed to get, and he replied, “about 47 inches per year is the average for Atlanta.”

That got me thinking about what we are “supposed” to get.  What is “the average,” and what does “average” mean? It’s true that Atlanta’s average annual rainfall is 47.12 inches per year.1 But I’m not convinced that it’s the amount of rain we’re supposed to get each year.  In the ‘80s, I remember having summers and falls with hardly any rainfall at all.  But both drought and excessive rainfall are normal. We don’t get the “average” every year. Some years we get more, and some years we get less, that’s how average works.

What is average? The average is the sum of all numbers in your series, divided by the number of items in your series.  It is merely a math calculation. 

If average annual rainfall for Atlanta is 47.12 inches, it is not the amount we are supposed to get each year.  Some years we get more and some years less, and that is what makes the math for the average come together.  We probably hardly ever get exactly 47.12 inches of rain in any one year.   

And the same is also true for other “averages” we hear about. In my world of helping people with their finances, I’m often asked, “Can we get the average return of the market?”  Knowing what “average” means, the answer is ‘no’ because you will not experience the “average” in any one year.  Dalbar has done studies showing that most investors experience a return way below the market averages.  The reasons are many but include the following factors:

  1. Investor behavior – pulling out of your investment strategy when the market takes a downturn. Leaving the market in a downturn will most likely result in missing the recovery before one gets back into the market.
  2. Needing to pull money out when the market turns bad for living expenses, emergency expenses or opportunities (for example: buying a rental property in 2008).
  3. Fees and taxes reducing returns.  Even if you invest in a low-cost index fund, you will not receive the “average” return on your account when you factor in even minimal fees and income taxes.
  4. Most investors are not invested in just one index or one asset class.  To lower risk and volatility, if one is in a 60% stock and 40% bond portfolio, one can never get the equity index average return. 

Understanding “average” should help investors know that not experiencing the average is normal.  What determines financial success in one’s life has more to do with the rate of savings, strategy, protection, and ability to take advantage of opportunities or weather emergencies.  I help my clients weather the storms of life and prepare to take advantage of opportunities that fall their way.