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3
Quick Introduction to ANP and FREQ

A good way to grasp the meaning of the FREQ is to picture your account as a black box. Now imagine there's a savings account inside the black box. What was the annual interest rate of that savings account? That rate is your fixed rate equivalent. In other words, if your account's FREQ clocks in at x%, that means that effectively, ignoring all the ups and downs that are now water under the bridge, you were running an x% savings account.

The FREQ is a very real measure. For example, if your FREQ is 0.7% for the trailing five year period, then you can say, “Gosh, that high-yield savings account had an annual interest rate of more than 0.7% even in the worst of times. Had I put my money there, I would have more now.”

For the example that we considered earlier, the FREQ is 25.99%. This is not the place to discuss how the FREQ is calculated. However, based on the definition of the FREQ as the replicating fixed rate, it is easy to verify and visualize that number. The blue line in the chart below is the portfolio value of the example (\$100,000 beginning balance and \$1,000,000 deposited half way through). The red line is the account balance of a savings account that pays 25.99% annually, with the same beginning balance and deposit.

We see that the ending balances are the same. Therefore, the 25.99% fixed rate account replicates the performance of the actual account. Hence, the FREQ equals 25.99%.

Compare the blue line in the chart above to the original mutual fund performance chart. This illustrates how the performance of the fund and the performance of your money are two different things. The mutual fund performance describes what happens to an initial investment, with no further deposits and withdrawals. The FREQ describes the performance of an investor's money, even in the presence of deposits and withdrawals, using the fixed rate account as a yardstick. Measuring the performance of one's money in this manner is also called money-weighted performance measurement.

Comparison of ANP and FREQ

The ANP is useful as a first, hands-on eye-opener for what happened to your money. After all, the goal of saving and investing is not rates and percentages, but to command wealth, be it for personal consumption or to support causes and charities. As an example, suppose you are considering quitting your job and living off your investment income. Last year's ANP tells you how much you could have withdrawn without digging into your principal. Needless to say, that number cannot predict the future. But it is one useful data point among others.

The FREQ, on the other hand, is a far better measure of performance, because it takes into account the amount of time that each dollar has spent in the account. The ANP treats all deposits equally, no matter when they were made. The FREQ knows that the longer your money is at work for you, the more gain you can expect from it.