1. The Money-Making Illusion You Might Be Under

Let's first examine the performance of two individuals, A and B, in their investments over the past four years:

Suppose A starts with a principal of 100,000. A earns 100% in the first year, loses 50% in the second year, earns 100% in the third year, and loses 50% in the fourth year.

B also starts with a principal of 100,000, earning 10% in the first year, 10% in the second year, 10% in the third year, and 10% in the fourth year.

At first glance, we notice that A's performance is significantly better, often doubling their investment, while B's returns are quite ordinary, with only a 10% gain each year. It would be no surprise if everyone believed that A's investment skills are clearly superior to B's, with A's investment return being 25% and B's only 10%. But what is the actual situation?

What is the return after four years?

A: In the first year, A earns 100%, bringing the total to 200,000 with principal and profit; in the second year, they lose 50%, bringing the total back to 100,000 with principal and profit; in the third year, they earn 100% again, bringing the total to 200,000 with principal and profit; in the fourth year, they lose 50%, and the total, including principal and profit, surprisingly returns to 100,000. Over four years, there is neither profit nor loss, and after accounting for transaction fees, there is actually a loss.

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B: In the first year, B earns 10%, totaling 121,000; by earning 10% each year, by the fourth year, the total is 146,000, with a return rate as high as 46%. After deducting transaction fees, B consistently makes money.

This calculation might seem counterintuitive, but that's right, only B is making money, while A is definitely losing money.

2. Not Losing Money Is Really Important

(The translation of the second point is not provided as it was not included in the original text.)Why doesn't A make money? Because all the money earned is lost. The more you earn, the more you lose, and in the end, everything is lost.

Is it true that losing less means making money? Actually, losing less can also be harmful to making money.

In the first year, you earn 20%, and in the second year, you lose 10%. When you calculate the accumulated return over two years, it's only 5%. However, if you earn 10% in the first year and still earn 10% in the second year, the accumulated return over two years is 21%, which is 11% more than before. Why? Because not losing money is crucial. Losing money in one year means that the earnings from the previous year are halved or even more, significantly reducing the return rate. Therefore, not losing money is the most important thing in investing.

3. How to calculate the investment return rate

We have been "deceived" by the concept of annual average return for many years. It is wrong to calculate the investment return rate using the arithmetic average; instead, we should use the geometric average to calculate the investment return rate.

Arithmetic average: Divide the sum of the returns by the number of years.

Geometric average: Multiply the returns and then take the root, with the number of roots equal to the number of years.

Calculating the investment return rate by simply averaging is incorrect, which is why we often see that we are making money but actually end up losing money when we calculate it.

4. Time is the compound interest of steady investment (investment return with a principal of 100,000)Today's 100,000 yuan, if it can grow steadily at a 10% return rate, will amount to 11.74 million in 50 years. Many people can afford 100,000 yuan now, but very few will be able to come up with more than 10 million in 50 years, because few can maintain the discipline to let their capital grow for them day in and day out over half a century. Warren Buffett once said, "Most people can't be bothered to get rich slowly." Fifty years is a long time, and few truly care about what will happen half a century from now.

5. Insights from Investment Returns

Three principles of return rates:

1. The Principle of Stability: Not losing money is crucial. This is the principle of preserving capital, where the profit rate must be a positive number.

2. The Principle of Geometry: The average return rate that fund managers show you is misleading; they calculate the arithmetic mean. In investments, the average return rate should be calculated using the geometric mean.

3. The Principle of Time: Steady earnings maintained over the long term can create miracles.

The ultimate goal in the investment world is the pursuit of stable profitability, where the size of the cost, the ratio of profit margins, and the continuity over time are the three decisive factors for the amount of profit.

Among these three factors, only time is a natural phenomenon that is fair to everyone, requiring no additional consideration. All it requires from you is one word: persistence.The magnitude of cost is the level of the starting point; of course, the larger the better. It is a good thing under the condition of positive profits, but if it is a negative interest rate, the larger it is, the less useful it is, and the greater the harm it causes.

Doing the right thing is far more important than doing things right. When personal capabilities are limited, the best approach is to choose the right thing. In terms of investment, this means selecting the correct investment tools and methods.

Do not harbor the illusion that regular investment can make you rich overnight or yield substantial profits in a short period. It is impossible, so one must be patient and not be overly elated by gains or saddened by losses. Otherwise, it is better to stay away from investing.