|Rates of return and the end game
Monday Januray 21, 2013
I think with the very low interest rate world we are currently
in, investors can look at fixed-income rates of return in the
1%-5% range and perhaps 4%-8% for most equities going forward.
If you have a mix of fixed income and equities in your portfolio,
a 6% overall rate of return is a reasonable expectation. Yes,
I know that seems a “low” rate of return (ROR). After all, you’ve
probably read of some investors making the “big score,” or you’ve
heard a friend or acquaintance boast about their astounding
rate of return over the previous year. But this is a dangerous
game to play, and I’ll explain why.
The consensus now is that we are in an extended era of low
interest rates, with a consequent expectation of lower returns
in equities too. I think the days of looking for 8%-10% growth
over the long term is gone, or at the least is an unrealistic
expectation. The U.S., Europe, and Japan, which 10 years ago
comprised most of the world’s economic output are slowing, because
of both debt and demographic shifts, and this won’t change anytime
soon. Realistically, expected rates of return are going to be
lower than they were a decade ago.
Too focused on rate of return
But what do I mean by “Rates of return (ROR) and the end game”?
I think far too many investors are too focused on ROR. What
did I make this year? What have I made since I started five
years ago? While those are reasonable questions, they bypass
the really important questions, which are these: “Am I on track
with my retirement goals” and “Will I have enough money in retirement
to do the things I want?”
When we first start investing, our goal is not to make 5% or
8% per year over the long term. Our goal is to save money to
educate our children, save for a comfortable retirement, or
reduce the income taxes we pay. Once we become seasoned investors
and became more educated about investing, however, we often
get sidetracked by ROR and sometimes make poor decisions as
a result of it.
There will be years where the investment returns are poor.
That is a fact of life. We are currently in a bad stretch, where
ROR has been mediocre for about 12 years. We obviously can’t
control the markets or our ROR, so what can we do? We can worry
less about markets and ROR and focus on our goals.
I have seen clients with ROR of only 4%-5%, but because they
kept adding money every month, their account went from $100,000
at the start of the year to $120,000 at the end of the year.
That’s an additional $20,000 that will help the clients come
retirement time. If in mediocre markets you can keep your bottom
line going in the right direction, then if we have a really
good year, all the better. But we don’t get too worried if that
doesn’t happen, because it’s uncontrollable. Just keep making
small adjustments to ensure you are moving ever forward and
doing the simple things right. Investing on a monthly basis,
making a lump sum buy on market dips to take advantage of lower
pricing, and taking advantage of free money (RRSPs and RESPs).
I have seen people move from a trusted advisor who was making
them money and transfer everything to an unknown advisor at
the suggestion of a friend who happened to earn more during
a period of time. They subsequently lost 40% over the next year.
Why did the friend make more money? It’s a result of having
different goals, different risk tolerance, different time horizon,
and so on. But they went ahead and blindly bought the same investments
as their friend, losing a trusted financial advisor in the process.
Why did they make the move? Impatience and focusing on the ROR
instead of the end game (the goals and/or plan). This is a recipe
for disaster. They also run the additional risk of the new financial
advisor being unscrupulous, doubling the chance for failure.
Concentrate on your end game
When you meet with your financial advisor in the months and
years ahead, try and focus on your goals, not the ROR. You can
hope to bump up your ROR by shifting fixed income to equities
(especially natural resources, precious metals, and emerging
markets), but remember that you are assuming additional risk
too in search of a higher ROR. Are you moving in the right direction?
Are you mitigating risk by having a fixed income element in
your portfolio? Are you investing monthly to move consistently
toward your goals? That should be your focus instead of chasing
last year’s winners or copying a friend’s portfolio in hopes
that it will work for you.
Always remember your end game. Make sure you keep working towards
it with a trusted advisor who has your best interests at heart.
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The foregoing is for general information purposes only and
is the opinion of the writer. This information is not intended
to provide specific personalized advice including, without limitation,
investment, financial, legal, accounting or tax advice. However,
please call the author to discuss your particular circumstances.