If you’ve ever looked at a mutual fund or ETF, you’ve probably seen a long list of historical returns followed by a familiar disclaimer:
“Past performance is no guarantee of future results.”
It’s one of the most common disclosures in investing, but it’s also one of the least understood.
Most investors glance at a fund’s average annual return and naturally assume they’re seeing a reliable picture of what they can expect in the future. Unfortunately, averages often hide the very information that matters most.
That’s why one of the most important concepts in investing is something statisticians call “the flaw of averages.”
Simply put, averages describe what happened. They don’t tell you how it happened, how much risk was involved, or whether you could realistically have stayed invested long enough to earn those returns.
The Average Return Trap
Imagine someone tells you a mutual fund averaged a 10% annual return over the past five years.
What picture comes to mind?
Most people imagine something fairly steady.
Perhaps the fund returned 8% one year, 11% the next, then 9%, 10%, and 12%.
That feels predictable.
The reality may have looked very different.
The fund may have experienced returns of positive 28%, negative 22%, positive 31%, negative 15%, and positive 18%.
The average is still about the same.
The experience is completely different.
That’s the problem with averages.
They tell you almost nothing about the journey.
And in investing, the journey often matters just as much as the destination.
Why Volatility Matters
Now imagine two different portfolios.
Both produce exactly the same average annual return over a decade.
Portfolio A experiences relatively steady returns with only modest fluctuations from year to year.
Portfolio B produces the same long-term average but with dramatic gains followed by equally dramatic losses.
Which one would you rather own?
For most investors, the answer is Portfolio A.
Not because it necessarily earns more money, but because it’s easier to live with.
Steadier returns create less emotional stress. Investors are less likely to panic during difficult markets, and they’re more likely to stay committed to their long-term plan.
This becomes even more important during retirement.
When you’re still working and contributing to your portfolio, market declines can actually provide opportunities to buy investments at lower prices.
Once you’re retired and taking withdrawals, however, large market declines early in retirement can permanently reduce the longevity of your portfolio. This is known as sequence of returns risk, and it’s one of the biggest risks retirees face.
Two portfolios with identical average returns can produce very different retirement outcomes depending on when those returns occur.
The Biggest Variable Isn’t Always the Investment
Here’s an uncomfortable truth.
Many investors never actually earn the returns their investments produce.
Why?
Because investing isn’t just about choosing good funds.
It’s about staying invested through good times and bad.
Unfortunately, human nature often gets in the way.
People tend to buy investments after they’ve performed well because they feel confident.
Then, after markets decline, fear takes over and they sell.
The investment itself didn’t fail.
Investor behavior did.
One of my favorite ways to describe this is simple:
“The average return belongs to the fund. Your return depends on whether you stay invested.”
That’s an important distinction because successful investing is often less about finding the perfect investment and more about developing the discipline to remain invested when emotions tell you otherwise.
Why Yesterday’s Winners May Not Be Tomorrow’s Winners
Another mistake investors make is assuming that strong past performance guarantees future success.
History tells us otherwise.
Markets evolve.
Interest rates rise and fall.
Inflation changes.
Economic leadership shifts.
Valuations expand and contract.
Entire industries emerge while others fade away.
The investment strategy that dominated the last decade may struggle during the next.
That’s why building a portfolio by simply chasing last year’s top-performing fund rarely leads to long-term success.
Past performance provides valuable context.
It does not provide certainty.
The Flaw of Averages
Perhaps the best way to understand this concept has nothing to do with investing.
Imagine you need to cross a river.
Someone tells you the river has an average depth of three feet.
Would you confidently walk across?
Probably not.
Why?
Because averages hide important details.
One section of the river may only be one foot deep, while another section may be eight feet deep.
The average is technically correct.
It just isn’t useful for making an informed decision.
Investing works the same way.
Average returns don’t tell you how deep the declines were, how frequently they occurred, or how difficult it would have been to remain invested during those periods.
A successful retirement plan isn’t built around average outcomes.
It’s built to survive the full range of possible outcomes.
What We Focus On Instead
At Zynergy, we don’t build portfolios by chasing last year’s winners.
Instead, we focus on principles that have stood the test of time.
Risk management.
Tax efficiency.
Low investment costs.
Long-term discipline.
Most importantly, we build portfolios around the goals of the Member sitting across the table—not around a performance leaderboard.
The objective isn’t to own the investment that performed best last year.
It’s to own the portfolio that’s most likely to help you accomplish your goals over the next 20 or 30 years.
The Bottom Line
Investment performance matters.
But understanding how those returns were achieved matters just as much.
Average returns can hide significant volatility, create unrealistic expectations, and encourage investors to focus on the wrong metrics.
Instead of asking, “How much did this investment make?”
Ask better questions.
How much risk did it take to earn those returns?
Could I realistically stay invested through difficult markets?
Does it fit my financial plan?
Those questions will do far more to improve your long-term success than chasing the highest historical return ever will.
As we often remind our Members:
“Investors don’t retire on average returns. They retire on the returns they actually experience.”
