Quizmaster, Doug Hutchinson, has come up with another great quiz for us regarding how volatility can affect wealth accumulation. Let’s see what the math has to say.
Good luck!
Which of the following managers (A,B or C) would you rather have invested with 3 years ago?
Consider this scenario:
| Manager A | Manager B | Manager C | |
| Year 1 | 5% | 5% | 5% |
| Year 2 | 5% | -5% | -10% |
| Year 3 | 5% | 15% | 20% |
| Average Annual Return: | 5% | 5% | 5% |
**Note that each of these managers has an average return of 5% over the past 3 years, but they each took different paths to get to that 5%. Would you be indifferent between all managers or would you prefer one manager over the others?
Solution:
The best way to approach this scenario is to determine which Manager provided the most wealth accumulation after 3 years.
Manager A: start with $100,000 invested at the beginning of Year 1
Year 1 Return: $100,000 x 1.05 = $105,000
Year 2 Return: $105,000 x 1.05 = $110,250
Year 3 Return: $110,250 x 1.05 = $115,762.50
Investing $100,00 at the start of Year 1 with Manager A would've given you $115,762.50 at the end of 3 years.
Manager B: start with $100,000 invested at the beginning of Year 1
Year 1 Return: $100,000 x 1.05 = $105,000
Year 2 Return: $105,000 x 0.95 = $99,750
Year 3 Return: $99,750 x 1.15 = $114,712.50
Investing $100,000 at the start of Year 1 with Manager B would've given you $114,712.50 at the end of 3 years.
Manager C: start with $100,000 invested at the beginning of Year 1
Year 1 Return: $100,000 x 1.05 = $105,000
Year 2 Return: $105,000 x 0.90 = $94,500
Year 3 Return: $94,500 x 1.20 = $113,400
Investing $100,000 at the start of Year 1 with Manager C would've given you $113,400 at the end of 3 years.
So, a portfolio invested in Manager A will accumulate the most wealth after 3 years. Note that the 3 managers all have different amounts of wealth accumulation after 3 years despite the fact that they had the same average returns over 3 years.
Among portfolios with the same arithmetic average returns (5% in this case) over multiple time periods, the portfolio with the lowest volatility (Manager A in this case) will have accumulated the most wealth at the end of the period.
This quiz is intended for informational and illustrative purposes only. This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The information presented is general information that does not take into account your individual circumstances, financial situation or needs, nor does it present a personalized recommendation to you. The information and opinions contained in this material are derived from sources deemed reliable, are not all-inclusive and are not guaranteed as to accuracy.
