If you’ve been learning about investing for any amount of time, you’ve probably received some emails or Facebook ads similar to this. It’s an old marketing ploy used by tons of options and stock newsletters* Are those types of returns possible? Yes, but not in the way you think…
Here’s the catch, most often when they talk about returns they are secretly referring to what are called annualized returns. Essentially all that means is that a pick of theirs may do very well over a period of days or weeks. They then estimate how much of a return you would get if they kept that rate of return up for an entire year. On top of this first catch, people tend not to notice that the recommendation “ideally” only uses a small percentage of the money (capital) in their account. They may not want you to spend any more than 2-5% of your money on any one stock, fund, option, etc.
Let’s Learn How To Lie With Numbers!!!
So your newsletter recommends an option to buy and you have $100,000 in an account.
(DO NOT be embarrassed if you have no way near this. This is just a round number)
The newsletter recommends an option to buy. It also recommends you not use more than 1% of your capital for this one trade.
That means you should spend more than 1% of your account on any one option recommendation. To make this easy, you spend all $1,000.
The option does very well and in 2 weeks has gone up 56%. Totally reasonable expectation with a decent options play. Now to lock in that options trade they recommend closing out the trade. So you’ve made 56% in 14 days. Super.
Here’s where the sneaky part comes in. 2 weeks is 14 days (obviously) and in finance we never use 365 days to estimate a year, we use 360.
So in 14 days we’re up 56%. As a decimal that is .56 (56% divided by 100 to get the decimal).
So how much of a return is that per day? We divide .56 by 14 = .04. The option made 4% per day. Not bad at all.
Now if we want to find out the annualized return we multiply the daily return rate by 360 (one financial year) So .04 x 360 = 14.4. Now multiply it by 100 to get that number as a percentage and we get 1,440%!!!!!
They just made you 1,440% (annualized) on just ONE recommendation!!!
Oh wait, we forgot that was only on $1,000… and really you only made 56% on that option. That’s $560…
Now $560 is nothing to sneeze at, obviously. But remember you have $100,000 in your account. $560 is .56% which the stock market may go up or down in a single day…
That newsletter made you .56% on your account, not 1,440%. Bit less impressive, huh?
This is how investment marketing works. They’re not REALLY lying, but they kinda are. They’re lying with numbers people don’t understand, not with words people DO understand. You just have to know how the math works and know where to find the disclosures. Next time you see an ad promising returns like this, ask yourself what is more realistic .56% or 1,440%. Good rule of thumb: if the primary marketing tool of an investment is the promise of a specific rate of return, run for the hills. Beware of wolves in newsletter’s clothing.