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The Hidden Risks Of Seeking Average Returns

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Steve Pomeranz, Average Returns

As the American humorist, Mark Twain used to say:

“There Are Lies, Damn Lies, and Then There Are Statistics”
…and in the financial world, few things are more dangerous than the statistic known as “Average”.

Here are two examples of the folly attributed to Average.
Can you drown in a lake whose average depth is 6 inches? Yes, you can. If the center of the lake’s depth is 40 feet and the depth at the shore is less than an inch, the AVERAGE depth may be 6 inches.

Can your body temperature be 98.6 but still die from heat? Yes, if you had your head in the freezer and your feet in the oven, you may die with an AVERAGE body temperature of 98.6
These are some silly examples to make a point. The statistic, AVERAGE, can hide many a dangerous situation and obscure the real facts.

Economically speaking, we often rely on averages to get a sense of how the economy is doing, how well the labor force is doing, for example.

For example, the average rate of economic progress looks pretty healthy at the moment, but a deeper dive into the numbers shows a wide disparity between the rich and middle-income Americans. On average, things are looking better but only because the average numbers are overwhelmed by the gains made for the wealthier among us. So once again, by wading in a little deeper, you can see through the distortion the word average conceals. For those reading this commentary online, I have provided the chart from Yahoo Finance.

The Chart shows the lowest 25% of wage earners have experienced living expenses growing faster than their income. Middle-income earners are basically treading water, meaning their income growth has just kept pace with higher costs. The biggest winners are the highest 10% of wage earners. Yet, on average, the numbers look rosy.

The statistics measuring household borrowing are also subject to the discrepancy. Decent Debt to Income numbers was hailed as good news because, although households borrowed more, consumers’ income rose alongside of it as well.

This made it seem that consumer debt was under control and stood at a reasonable percentage relative to the income needed to pay it off. The so-called debt-to-income ratio stood at 86%, significantly lower than its all-time high of 116% in 2008 at the peak of the housing bubble. Thus, American households were financially healthy and were not experiencing levels of stress covering their payoff of the debt.

Once again, these average numbers don’t highlight the difficulty lower income households have to pay off that debt.
According to the Yahoo Finance article, a more sophisticated analysis found that when comparing people’s net worth against their income, rich households who have benefitted from a rising stock market and rising home prices show healthier balance sheets. These same ratios have fallen for households at all income levels except for the top 10%. The report goes on to say that these lower-income families are more fragile than ever, suffering from increased debt, stagnant or declining wages, and lack of assets.

There are differing opinions as to whether the economy is in for some economic peril or things are alright, but it is never a good sign to see a large number of already vulnerable people making decisions which, if the economy turns sour, may blow up in their faces and cause the poverty cycle to repeat once again.
Anyway, getting back to today’s theme, remember that any statistic that uses the average or the mean rate of something needs to be looked at more carefully if only because the underlying numbers may tell the truer story.

So, if you can’t swim, make sure the depth of the lake you are venturing into is proportionate to the average depth and something you can handle. If it is in fact too deep in some parts, wear a life jacket, stay in the boat, or at the very least, wear some water wings.

Investing involves risk and investors should carefully consider their own investment objectives and never rely on any single chart, graph, or marketing piece to make decisions. The information contained herein is intended for information only, is not a recommendation to buy or sell any securities, and should not be considered investment advice.  Please contact your financial advisor with questions about your specific needs and circumstances.  There are no investment strategies, including diversification, that guarantee a profit or protect against loss. Past performance doesn’t guarantee future results. Equity investing involves market risk, including possible loss of principal.  All data quoted in this piece is for informational purposes only, and author does not warrant the accuracy, completeness, timeliness, or any other characteristic of the data. All data are driven from publicly available information and has not been independently verified by the author.