Last week a prospective client asked me a very good question. They asked whether I have data that shows what investment returns my clients have generated. Whilst this sounds like a logical question, my response was that not only did I not have this data
[1], but it also wouldn’t necessarily be that useful. The reason is that investment returns are highly dependent on a client’s stage of life, their risk profile, the quantum of their investable income, their starting financial position and so on. Unless all those factors are identical to this prospective client, the returns are not relevant.
But the question got me thinking; how important are investment returns anyway?
Short term investment returns don’t give you the full story
If I told you that my clients enjoyed a 100% return over the past 12 months, would you be impressed? Of course, no one’s going to be upset with that return but it tells me nothing about:
1. The risk that I took to achieve that return. High returns are almost impossible to achieve without taking high risk; and
2. Whether that return is sustainable. The
laws of compounding growth tell us that it’s more powerful to consistently generate a sustainable return (e.g. 8% p.a.) over many decades. That should be your goal.
Returns become more important over long periods of time
It is very possible that when I start working with a client, in the short-run, they might be financially worse off. I have two examples to demonstrate this.
The first example is when I advise them to invest in property. In that first year they pay for a lot of large expenses such as stamp duty and buyers’ agents fees. This diminishes their net asset position.
The second example occurred last year when we had actively reduced exposure to the seemingly overvalued US tech sector prior to Covid. As we know, the tech sector was the greatest beneficiary of Covid during 2020. Consequently, our portfolios under-performed over the year to December 2020. However, based on initial investigations, it appears our portfolios have more than made up for that under-performance over the year ended June 2021 (being underweight tech has served us very well to date in calendar year 2021).
The lesson these two examples demonstrate is that sometimes short term returns suffer in the pursuit of maximising long-term returns. This is acceptable, unavoidable and necessary.
I can’t control markets or returns
I can’t control investment returns, especially in the short-term. No one can. In the short term, markets can be irrational, unpredictable and highly volatile. No one in the world has developed a model to reliably predict short-term returns with any meaningful consistency.
The factors that I can control (on behalf of my clients) include investment fees, the methodology we employ (i.e. whether its robust, tested and evidenced-based), the investment strategy/plan that we formulate, asset allocation and the quality of the investment. In the long run, all these factors will be responsible for delivering investment returns.
To use an analogy, a personal trainer doesn’t have any control over the weight her client loses in the short term. All she can control is how much her client exercises, the meal plan that her client follows and other environmental factors. The weight her client loses is merely a consequence of her client’s behaviours. But if her client follows her advice consistently over many months and years, the results become more predictable.
In fact, the value of advice has little to do with investment returns
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