Sleight-of-Hand Writing Styles
Lately many financial newsletter writers refer to an annualized gain, as opposed to the gain on a single transaction. So a 12% annualized gain might be only a 1% gain attributed to the gain realized on one trade that took place in a single thirty-day period. Should this annualize return persuade you to follow this investment advice? No, not really. Don’t be fooled by the reference to an annualized return that is not based on history, as opposed to it being used to predict future returns.
The use of an annualized return gets bantered around the investment world when volatility increases, like in the present.
In a volatile market financial newsletter writers have as difficult time as you do to replicate a real annual return of any significance. So when they tell you Warren Buffett doesn't know what he's doing that is in and of itself, another sleight of the pen.
This reference to the annual return is a sleight of hand in an attempt to sell more newsletters during volatile markets. The writers while insinuating their advice is like gold sitting two inches under the Earth's surface implore you to see their advice as the way to get to the gold. "Look at this unbelievable return of 53% annualized! Follow my advice and I will show you where to find the gold!" By using an annualized gain the writer is avoiding any reference to how the advice actually played out for this single investment transaction, but more importantly, avoiding any discussion of whether this transaction can be replicated.
An annualized return is a way to avoid talking about the real historical returns you can expect from following their advice. What they are not saying is that in a volatile market they are having just as hard a time coming up with advice that will produce a consistent return. And that is the honest truth and what they should be saying to their readership. Anything else is simply sleight of hand and no better than throwing a dart at a stock list page in the Wall Street Journal.
So when the writer points out an annualized gain of 53%, 16% and 12% it should be meaningless to a wise investor when deciding whether this analyst’s advice is worth following. A single event, that can never be replicated, or that is seldom replicated can be annualized to 100%, but if it happened once in twelve months with a $1.00 investment it simply means one time you made $1.00 on a $1.00 investment. That event would hardly be worth following when you have from ten thousand to a million dollars to invest.
Here is an example to demonstrate just how preposterous the annualized return is for predicting future events (returns). I'm 61 and last year took up the game of golf. I stink at it and I know it. But what if I played one hole and shot a three under par? Let me "annualize" my abilities against professional golfer Jordan Spieth. The use of an annualized return for a single transaction is sort of like shooting three under par on one hole on a golf course and claiming that on "an annualized basis" I beat Jordan Spieth's course record. I never played the other 17 holes; I simply "annualize" my score from one hole I played. Sorry, but the financial analysts will not be getting a green jacket with this type of advice.
Watch Tony Comito doing the Pea in the Shell trick.