What You Shouldn’t Be Watching
Returns! Being obsessed with returns is probably the most underrated weakness of the investor. Does it make sense to look at short-term returns? I believe not. I’ve found it makes more sense to talk about whether we’re on track rather than returns. There will always be something hotter and with a better return than what you’ve got. I do believe that over the long-term, asset allocation dictates over 90% of the return in a portfolio.* If we want to put probability of success in your planning, we need to ignore short-term returns, manage risk tolerance, be adequately allocated and diversified, and do what it takes to stay on track.
Most of you can tell me what day you want to retire. Some of you can tell me how much you need or want at retirement. Some of you can tell me how much you have invested today and a few of you can tell me your investments’ expected return over your lifetime. These four things can be put on a chart to see where they intersect:
- Data about your retirement
- Cash flow need at retirement
- Assets to provide that cash flow
- Expected returns
For some of you they may intersect at age 45. For most, they intersect somewhere between ages 60 and 95. If these four lines do not intersect where you would like, then we have the following five choices:
- Retire later
- Retire on less
- Invest more
- Increase returns
- Do nothing
It is quite apparent that most people do number 5 because 60% of workers aged 55 and older in America have less than $100,000 saved for retirement, and 43% of this group have less than $25,000.** Let’s assume you’re part of the 40% who are doing better at saving and investing. Has watching returns improved your results?
Consciously or subconsciously watching returns leads to emotional decisions. The vast majority of people will do exactly what they know they shouldn’t do if they are obsessed with returns. For example, while some portfolios with numerous asset classes that invest in thousands of different stocks may have underperformed the S&P the last few months, is this the time to get out of the well diversified portfolio and buy into something that only represents 500 of 16,000 stocks in the world? I do not believe so.
We all know that if we buy high or when an asset class is in favor that probably won’t be the best purchase we ever make. We also know that if we buy low in the market that long-term we probably will get better returns than if we buy when it’s high. Yet, when something does well for a short period of time and something else does not, our instinct leads us to sell what is low and buy what is high. As a general rule, if you follow this habit you will get less return.
A recent study conducted by Dimensional Funds compared the returns of investments that had winning track records at beating their respective benchmarks and re-evaluated their returns in the subsequent 3 year period following their success. They found only 39% of equity investments and only 16% of bond investments continued their winning streak. This leads us to believe, if you always buy the hot investments, chances are you will underperform the market rather than outperform in the long-term.
Your response may be, “Well, I don’t make those decisions.” However, if you’re consciously or subconsciously watching returns and markets are doing well you put more money in. You stretch to find money to invest. Yet when markets are doing poorly, and the media is telling you how terrible everything is, you refrain consciously or subconsciously from putting money into a market that almost without doubt long-term is a good buy. Unfortunately most of us don’t realize when our subconscious is taking over. I’ve seen very intelligent, knowledgeable people make poor investment choices because they’re watching short-term returns.
Success comes from having a plan. From taking actions that put probability of success on our side. Not from outsmarting, timing or out picking the market. No one knows what the market is going to do tomorrow. No one! So stop watching!
* Study of determinants of portfolio performance published by Brinson, Hood and Beebower in the Financial Analysts’ Journal. Jan/Feb 1995
**Retirement Confidence Survey, Employee Benefit Research Institute, 2013
***The US Mutual Fund Landscape, Dimensional Funds, 2014
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Stock investing involves risk including potential loss of principal. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. No strategy ensures success or protects against a loss.
