The Illusion of High Average Returns
When I first started investing, like many others, I wanted to hit home runs. I’d aim for portfolio gains far above and, in some cases, unrealistic. I remember thinking: “Even if I lose 20% one year, I’ll more than make up for it with a 40% gain next year.”
But I quickly learned that math doesn’t work the way we think it does when it comes to investing.
The hard truth? Your average return is not the same as your actual return. And chasing big gains can quietly destroy long-term performance if your losses are as wild.
Let’s break this down using real numbers — and focus on portfolio-level returns.
The Illusion of Average Returns
Let’s say you’re offered two investment paths over 10 years:
Path A: A portfolio return of 10% compounded annually.
Path B: A portfolio that alternates yearly between -20% and +40%.
At first glance, Path B looks exciting. The average return is (+40% + -20%) / 2 = 10%, so just like Path A, right?
Wrong.
Let’s Do the Math: -20%, +40%… Then What?
Let’s assume you start with $10,000.
Year 1: -20% → $8,000
Year 2: +40% → $11,200
Year 3: -20% → $8,960
Year 4: +40% → $12,544
Year 5: -20% → $10,035
Year 6: +40% → $14,049
Year 7: -20% → $11,239
Year 8: +40% → $15,734
Year 9: -20% → $12,587
Year 10: +40% → $17,621
After 10 years, your portfolio grows to $17,621. Solid return nonetheless: gain of 76.21% over 10 years.
Now, compare this to Path A: a 10% annual compound return.
$10,000 compounded at 10% for 10 years = $25,937
Big difference, right?
Even though both paths had the same average return of 10%, the actual portfolio value is over $8,000 higher with the consistent 10% compound return. Total return over 10 years in Path A is 159.37%
That’s the power of compounding. And the danger of volatility. It’s all fun and games until volatility high fives you in the face with a chair.
Consistent Growth vs. Volatility: Who Wins?
Let’s be clear: volatility isn’t always bad. It can create opportunity. But if your portfolio is swinging wildly year to year, the compounding effect gets disrupted.
Here’s why:
Losses hurt more than gains help. A 20% loss requires a 25% gain just to break even.
Volatility reduces your geometric (realized) return, even if the arithmetic average looks the same.
It’s not about how exciting a portfolio looks. It’s about how your capital actually grows.
Why Compounding Wins Every Time
When it comes to long-term investing, boring can be beautiful.
A portfolio that compounds steadily at 10% may not make headlines. But over time, it crushes portfolios that swing between highs and lows.
If you’re building wealth for the long run — retirement, financial independence — you need to embrace consistency of returns.
The Real Lesson for Long-Term Investors
This isn’t about picking the “safe” route. It’s about understanding how money grows.
A steady return means you’re always building on a stronger base. You’re not constantly trying to recover from a setback. And when the power of compounding kicks in, your portfolio accelerates.
So the next time you’re comparing portfolio strategies, don’t just look at average returns.
Ask: What’s the actual compounded outcome? What’s the risk of loss? And can I sleep at night?
Because in the end, it’s not about chasing the wildest returns.
It’s about ending up with the biggest portfolio.