Beware the Average

Many years ago, while on a family trip to California, we enjoyed some time at the pool. Watching our youngest son splashing around in the pool reminded me of how obstinate he was in learning how to swim. This wasn’t for lack of ability — he just flat-out refused to learn to swim (it’s possible he takes after his father in the area of stubbornness). Needless to say, it was nerve-wracking taking him to the pool before he learned to swim.

What would you think if I told you that when we took him to the pool before he knew how to swim, the only information we asked the lifeguards for was the average depth of the pool? What if we had no regard for the deeper end of the pool before letting him go in by himself, just as long as he was taller than the average depth?

Making a decision to let our three-and-a-half foot tall son go swimming by himself in a pool whose average depth is three feet is as foolish and reckless as making investment decisions based simply on the average return of a particular investment.

Too many people find themselves enticed by the allure of the average. Before you invest, you need to understand more than just the average historical or expected return of an investment. Among other things, you need to know what the historical and expected highs and lows are. Just like two pools with the same average depth can be very different, two investments with the same average return can perform very differently over time and can dramatically affect your chances of achieving financial success.