What’s the Difference Between Average and Actual Rate of Return?
An average rate of return can mask losses over time, so what investors really want to keep an eye on is the actual rate of return.

If an investment adviser touts an impressive average rate of return, be very wary, because losses can “hide” among the gains and hinder your financial success. Let’s explore the meaning of average rate of return vs. actual rate of return.
Your most compelling reason to make an investment choice most likely may be based on one performance criterion: rate of return. But are you looking at it the right way? When meeting with potential clients, I’ll often get asked what kind of average rate of return they can expect. But if you are relying on the average rate of return, you’re making a big mistake. Be careful to not fall prey to this type of thinking and possibly get taken advantage of.
There are actually two different types of rate of return, and they are not created equal: average rate of return and real, or actual, rate of return. The worst result of making investing decisions without understanding how rates of return work, coupled with how the rates are affected by sequence of returns risk, is that you could drastically shorten the amount of time that your money will last in retirement.

Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
What Is an Average Rate of Return?
Average rate of return is a simple calculation: Add up all of your annual investment returns and divide them by the time commitment. Financial advisers often use average rate of return as an advertisement for whatever product they are usually pitching.
For example, let’s examine the following $100,000 investment over a five-year period:
- Year 1 = $107,000 (7%)
- Year 2 = $114,490 (7%)
- Year 3 = $122,504 (7%)
- Year 4 = $131,080 (7%)
- Year 5 = $140,256 (7%)
As you can see, after five years, the investment had an average rate of return of 7%. This was accomplished by adding up each annual return and dividing that number over the five-year period. In fact, I often see projections from other financial advisers that use almost verbatim the example above. But you know there will never be a five-year period where investment returns will be exactly the same each year.
What many might not realize with an average rate of return is that due to the nature of the calculation, gains during some years can obscure losses in others. The end result is that while an average gain may look good, it may leave you with less money in your pocket than expected. For example, shares of Walmart (NYSE: WMT) returned 9.1% in 2014, lost 28.6% in 2015, gained 12.8% in 2016, gained 42.9% in 2017 and lost 5.7% in 2018. The average return of Walmart stock over those five years is 6.1% (30.5% ÷ 5 years = 6.1%). Any type of stock, bond or mutual fund investment will always have both gains and losses.
What Is Actual Rate of Return?
Actual rate of return is a process of recalculating and adjusting investment returns to account for both gains and losses.
For example, let’s examine the following $100,000 investment over a five-year period:
- Year 1 = $120,000 (20%)
- Year 2 = $130,800 (9%)
- Year 3 = $107,256 (-18%)
- Year 4 = $116,909 (9%)
- Year 5 = $134,445 (15%)
Once again, after doing the math, you will see that after five years, this investment also had an average rate of return of 7%. The key distinction is the end result of $134,445, or an actual rate of return of almost 6.1%, is almost $6,000 less than the previous example of $140,256. The average rate of return might have been the same, but the money in your pocket certainly isn’t.
The Bottom Line: Actual Rate of Return Is Much More Revealing
Investors should be interested in the actual rate of return – not an average – as investment losses can be easily hidden by using an average rate of return.
If you viewed this as only a simple equation, then there isn’t any difference, as both examples ended up averaging 7%. However, from an actual investment value, including both gains and losses, there is an obvious disparity.
When working with a financial professional touting their average rate of return, request that they show the performance with actual dollar amounts.
How Sequence of Returns Risk Affects Rate of Return
As we age, the risk of loss can substantially diminish the ability to make our money last in retirement. According to a Allianz Life, 63% of Americans fear running out of money in retirement more than they fear death.
While losses might not impact us during the accumulation stage in our working years, they will definitely hurt us in our distribution stage in retirement.
Let’s use the previous two examples but include an annual $4,000 withdrawal:
Example #1:
- Year 1 = $107,000 (7%) - $4,000
- Year 2 = $110,210 (7%) - $4,000
- Year 3 = $113,645 (7%) - $4,000
- Year 4 = $117,320 (7%) - $4,000
- Year 5 = $121,252 (7%) - $4,000
Example #2:
- Year 1 = $120,000 (20%) - $4,000
- Year 2 = $126,440 (9%) - $4,000
- Year 3 = $100,401 (-18%) - $4,000
- Year 4 = $105,077 (9%) - $4,000
- Year 5 = $116,239 (15%) - $4,000
Per the results above, the first example was still $5,000 ahead of the second one after withdrawals were accounted for. As a result, one loss changed the balance at the end of the fifth year, even though the average rate of return was the same.
Holding losses to a minimum with proper investment allocation, especially when approaching retirement, can have a significant impact on your financial success rate.
This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.
Carlos Dias Jr. is a financial adviser, public speaker and president of Dias Wealth LLC, in the Orlando, Florida, area, offering strategic financial planning services to business owners, executives, retirees and professional athletes. Carlos is a nationally syndicated columnist for Kiplinger and has contributed, been featured or quoted in over 100 publications, including Forbes, MarketWatch, Bloomberg, CNBC, The Wall Street Journal, U.S. News & World Report, USA Today and several others. He's also been interviewed on various radio and television stations. Carlos is trilingual, fluent in both Portuguese and Spanish.
-
-
New Mexico Rebate Checks Up to $1,000 Coming in June
New Mexico rebate checks will be sent soon. Here's what you should know.
By Katelyn Washington • Published
-
Should Graduates Spend or Save Their Gift Money? 14 Strategies to Consider
Financial experts share tips for deciding how to treat monetary gifts.
By Kiplinger Advisor Collective • Published
-
Retirement Planning with Life Insurance
An indexed universal life insurance policy can help you with tax mitigation and extra retirement income in addition to death benefits for your beneficiaries.
By Mike Decker • Published
-
Which Retirement Accounts Should You Withdraw From First?
Here’s a standard order for when you should tap which account when you’re in retirement.
By Evan T. Beach, CFP®, AWMA® • Published
-
Nervous About the Markets and Economy? Consider History
To put things in perspective, focus on what you can control and remember that the ups and downs of the markets and economy can be cyclical.
By Erin Wood, CFP®, CRPC®, FBSⓇ • Published
-
Expecting a Recession? Seven Steps to Help You Power Through
Instead of panicking, consider opportunities to add flexibility and resilience to your financial position. These steps can help you enter a potential recession from a position of strength.
By Christian Mitchell • Published
-
What Is Indexed Universal Life Insurance and How Does It Work?
This permanent life insurance provides a death benefit to your beneficiaries but also offers a cash-value component that can grow over time.
By Mike Decker • Published
-
How to Fail as a Leader
The authors of the new book 'Real-Time Leadership' outline the traits of effective leaders (kindness is key) and what will ensure a leader’s failure.
By H. Dennis Beaver, Esq. • Published
-
Are You Worried About Running Out of Money in Retirement?
Planning that integrates income annuities can help alleviate the No. 1 fear of retirees, even in worst-case investment scenarios and when living way beyond your life expectancy.
By Jerry Golden, Investment Adviser Representative • Published
-
Three Ways Charitable Organizations Can Boost Public Trust
Silicon Valley Bank’s collapse adds to distrust in institutions, and that’s affecting nonprofits and grantmakers. Fresh expressions of transparency can show that the nonprofit sector is different.
By Stephen Kump • Published