A mutual fund representative came into my office one day, and gave me a lesson I still remember -- and use -- to this day. On a sheet of paper he wrote "Mutual Fund A" and "Mutual Fund B" side-by-side. Fund A was a "rock 'n roll" type fund providing a 70% return in Year 1, but then lost 80% the next year, and gave a 31% return the next. Fund B provided a 7% return each of the three years.
Now, pull out your calculators!
You can see by adding the returns of each of the three years for the funds and dividing by three, you get the "average" annual yield. Each fund had a 21% overall return, and a 7% average annual return. So, they're the same, right?
Of course not!
Put $1,000 in Fund A. After Year 1, you have $1,700. Of course, in Year 2, you lose 80% or $1,360, so you're left with only $340. Year three gives you a 31% return on that amount, so you end Year 3 with $445.40.
Put $1,000 in Fund B. After Year 1, you have $1,070. With another 7% return in Year 2, you have $1,144.90. And in Year three, you end up with another 7% to end up with $1,225.04 -- or $779.64 more than Fund A.
Of course, this doesn't have to be labeled "Mutual Fund A" or "Mutual Fund B" as you can substitute "Stock A" or "Investment B" or really anything. But one thing is for sure: it pays to be "boring" by collecting consistent returns!
Now, I know what that old fable about the tortoise & the hare was trying to tell me...
