Q: In your recent MarketWatch article you implied that if you are offered two investments, one with a 10% average annual return and one with a 10% compound annual growth rate, that you would likely be better off choosing the latter? Why is that the case?
A: Compound is the only return that matters for the long term. The average rate of return, with a volatile security, will overstate the expected rate of return. In an upcoming article on Marketwatch about combining 4 major asset classes, I include a table that lists the average and compound rate of return for each of the four asset classes. The difference is as much as 4% a year. The compound return represents the real return you would get but the average return understates the impact of the years the investment lost money. The compound rate of return for small cap value is 13.6% compared to an average return of 18.2%. At a 13.6% growth rate you double your money every 5.3 years. At 18.2% the money doubles every 4 years. Anyone who uses the average return is either purposely misleading investors or ignorant of how compounding works.