Lies and Rates of Return: Why Rate of Return Is Not an Interest Rate

/ Published:

7 December 2024

/ Updated:

30 May 2026

/ Read Time:

6 minutes

In Brief:

Rate of return and interest rate are not the same thing — and conflating them is one of the most common (and costly) errors in conventional financial advice. Rate of return is a backward-looking measurement of what happened; interest rate is used to calculate what will happen. Applying an average rate of return as if it were a guaranteed interest rate leads to wildly incorrect projections of future wealth.

What rate of return actually means — and what it doesn’t
How interest rate differs from rate of return
Why the Rule of 72 breaks down in volatile markets
The math behind average vs. compound rates of return
Why volume of return matters more than rate of return
What this means for your financial planning

Two Numbers That Are Not the Same Thing

Financial professionals and popular financial entertainers routinely use “rate of return” and “interest rate” as if they were interchangeable. They are not — and the difference matters enormously when you are projecting future wealth.

Rate of Return (ROR) is the percentage change in the value of an investment over a specific period, expressed as a percentage of its initial cost:

ROR (%) = ((Final Value – Initial Cost) / Initial Cost) × 100

Interest rate, on the other hand, is the amount of interest due (or paid) per period, expressed as a proportion of the principal sum borrowed (or the present value of an interest-bearing account):

Future Value = Present Value × (1 + Interest Rate) ^ Number of Compounding Periods

With algebra, you can solve for the interest rate itself:

Interest Rate = ((Future Value / Present Value) ^ (1 / Number of Periods)) – 1

This is also the formula for Compound Annual Growth Rate (CAGR), sometimes called the compound rate of return.

Example: $100 grows to $106.09 over 2 years. ((106.09 / 100.00) ^ (1/2)) – 1 = 3% interest rate / CAGR

The Critical Difference: Time

Interest rate is always calculated for a given number of periods. Without knowing the number of periods, you cannot calculate a meaningful interest rate — and annual is assumed when no period is stated.

Rate of return, by contrast, covers only a single period — and without knowing the length of that period, the number is nearly meaningless.

A 20% rate of return sounds excellent. Invest $100, get $120 back. (120 – 100) / 100 × 100 = 20%

But what if that took 20 years to earn that extra $20? ((120 / 100) ^ (1/20)) – 1 = 0.916% interest rate / CAGR

That is a dramatic difference — and it will have a significant impact on long-term financial planning.

Why the Rule of 72 Breaks Down

The Rule of 72 is way of estimating how long it takes to double your money at a given interest rate. Simply divide 72 by the interest rate to get an approximate time. For example, at 12%, the rule says you should double your money in 6 years.

Year	BOY Value	EOY Value	Annual ROR	CAGR
1	$ 100.00	$ 112.00	12%	12%
2	$ 112.00	$ 125.44	12%	12%
3	$ 125.44	$ 140.49	12%	12%
4	$ 140.49	$ 157.35	12%	12%
5	$ 157.35	$ 176.23	12%	12%
6	$ 176.23	$ 197.38	12%	12%

The Rule of 72 is not actually a rule — it is a mathematical shortcut. It works reasonably well for nonvolatile, predictable returns. It is dubious at best when applied to volatile markets.

The Volatility Problem: Same Average, Very Different Outcomes

Consider two hypothetical portfolios — each running 6 years, 5 positive one negative. And each with an average annual ROR of 12%, but with very different ending values.

Year	BOY Value	EOY Value	Annual ROR	CAGR
1	$ 100.00	$ 120.00	20%	20%
2	$ 120.00	$ 134.40	12%	15.93%
3	$ 134.40	$ 161.28	20%	17.27%
4	$ 161.28	$ 112.90	-30%	3.08%
5	$ 112.90	$ 146.76	30%	7.97%
6	$ 146.76	$ 176.12	20%	9.89%

Year	BOY Value	EOY Value	Annual ROR	CAGR
1	$ 100.00	$ 124.00	24%	24%
2	$ 124.00	$ 153.76	24%	24%
3	$ 153.76	$ 190.66	24%	24%
4	$ 190.66	$ 238.33	25%	24.25%
5	$ 238.33	$ 297.91	25%	24.4%
6	$ 297.91	$ 148.96	-50%	6.87%

The first ends with $176.12 — a compound annual growth rate of 9.89%. Due to the losses in year 4, you would need an additional year at 12% return to have doubled your money.

The second ends with $148.96 — a compound annual growth rate of 6.87%, despite an average annual ROR of 12%. That would require nearly 3 additional years at 12% to recover and double the original investment.

The Fallacy of Equivocation in Financial Advice

Some popular financial entertainers instruct callers to “find a mutual fund that provides a 10% rate of return” and then calculate future value by plugging that number into an interest rate calculator. This commits two related errors:

The gambler’s fallacy — assuming past performance predicts future results, despite every prospectus stating otherwise.
The fallacy of equivocation — using “rate of return” and “interest rate” as if they mean the same thing.

Ask yourself: if you could get a savings account with a guaranteed 10% interest rate, would you put any money in the stock market?

Rate of return and interest rate are not interchangeable. Conflating them produces dangerously optimistic projections.

Volume of Return Matters More Than Rate of Return

To make this concrete, consider a five-year sequence:

Year 1: +100% → $100 becomes $200
Year 2: -50% → $200 becomes $100 (average ROR so far: 25%; compound: 0%)
Year 3: +50% → $100 becomes $150 (average: 33.3%; compound: 14.5%)
Year 4: -25% → $150 becomes $112.50 (average: 19%; compound: 2.99%)
Year 5: -25% → $112.50 becomes $84.38 (average: 10%; compound: -3.34%)

After five years with an average annual rate of return of 10% — the exact figure frequently cited in conventional financial advice — you have less money than you started with. The compound rate of return is -3.34%.

This is why Will Rogers quipped: “I am not so much concerned with the return on capital as I am with the return of capital.”

You can lose a great deal of money behind numbers showing consistently positive average annual return. There are lies, damned lies, and statistics. Rate of return is a statistical measurement — useful for analyzing past performance. Applying it to predict future values in volatile markets is not valid. It is only valid for prediction in assets with guarantees.

What This Means for Controlling Your Banking Function

The distinction between rate of return and interest rate is not academic. It determines whether your long-term projections are grounded in reality or in optimistic fiction.

Conventional finance ignores the banking function (storage, movement, and repayment) entirely — and then compounds that error by modeling future wealth using average rates of return as if they were guaranteed interest rates. As the math in this article demonstrates, those two numbers are not the same.

But there is a deeper point. Even if the rate projections were honest, rate is the wrong thing to optimize. Volume of return matters more than rate of return. Five percent of $100,000 is more than ten percent of $10,000. Controlling the banking function — keeping capital moving, accessible, and working — is how volume is built. Controlling the banking function is the most significant financial decision a family can make, and it is the one conventional advice never addresses.

If you’re ready to take control of the banking function, or just want to learn more, book a free call with an advisor today.

Semper Reformanda.

What is the difference between rate of return and interest rate?

Rate of return is a backward-looking measurement: it expresses the percentage change in value of an investment over a single past period, without regard to how long that period was. Interest rate is a forward-looking variable used to calculate future value over a defined number of compounding periods. The two require different formulas and answer different questions — using them interchangeably produces incorrect financial projections.

What is CAGR, and how does it relate to interest rate?

CAGR (Compound Annual Growth Rate) is mathematically identical to the compound interest rate formula: ((Future Value / Present Value) ^ (1 / Number of Periods)) – 1. It is constant compound rate at which an investment would have grown if it had increased at a steady pace, effectively smoothing out volatility and year-to-year fluctuations. CAGR is the correct way to compare volatile investment performance to guaranteed-rate alternatives.

Why doesn’t the Rule of 72 work for volatile investments?

The Rule of 72 estimates doubling time by dividing 72 by the interest rate. It is a shortcut that works reasonably well for consistent, nonvolatile returns. In volatile markets, however, the sequence of gains and losses matters — a single large loss can destroy years of positive returns, and the average rate of return will not reflect actual compound growth. The Rule of 72 is only reliable when the annual return is stable and predictable.

Why does a 10% average rate of return not mean your money grows at 10% per year?

Average rate of return is an arithmetic mean — it adds up annual returns and divides by the number of years. Compound rate of return (CAGR) reflects what actually happened to the money, accounting for the compounding effect of both gains and losses. Volatility causes the compound rate to fall below the average rate. In the five-year example in this article, a 10% average annual rate of return produced a -3.34% compound rate of return, leaving the investor with less money than they started with.

William Fullington is the founder of Reformed Finance LLC and an Authorized Infinite Banking Practitioner with the Nelson Nash Institute. He is a licensed life insurance producer and retired Air Force officer who helps Christian families understand the Infinite Banking Concept, whole life insurance policy design, biblical stewardship, and the importance of controlling the banking function in their family economy.