• Jeff Burke

What Rate of Return Should Your Portofilo Deliver?

As investors, many of us watch to see how the stock market is doing on some sort of regular basis. We have seen the big market collapses of the dot com bubble, financial crisis and more recently this spring due to Covid. We have seen massive market recoveries in recent history such as 2009 and this summer/fall as the economy tries to recover from Covid shutdowns.


As financial advisors, we often speak to clients about their investments with projections in the 6-8% range. The truth is only three times since 1930 has the annual rate of return actually been in that range for a given year. A look at the chart below shows that actual returns tend to be much more volatile than that.




So what should you be looking for as a proper rate of return for your portfolio? How many of you have heard someone you know saying they made a killing on a particular stock and found yourself feeling a little jealous that you weren’t in on that action as you can’t help but think this person just fast tracked their retirement by five years. This might make you think that if you’re not getting 35% plus in returns you’re missing out.


The truth, as with most matters in personal finance, is that it depends on your situation. The ‘market’ may be up 15% in a given year and you may find yourself looking at your own returns and it is only up 10%. Should you be upset about this? Maybe, maybe not. If you are 26 and invested fully in a growth portfolio you may want to look at things. For the rest of us, remember to get that 15% return you would have to be 100% invested in that particular index. In this case, if we are talking about the S&P 500, you would need 100% of your investments in the IVV ETF (iShares Core S&P 500 fund) for example. Now don’t get me wrong. This is a good fund (or another S&P 500 index fund) and absolutely has a place as one of your core holdings, but I don’t think anyone would ever feel comfortable having every penny they have invested in a single fund even if that was a fairly diverse fund.


The moment you add another fund into the mix you will get away from that specific 15% market return. Say you add an International fund as 20% of your portfolio and that space doesn’t perform as well this year and is only up 5%. Now your portfolio has an overall return of 13%. Again, should we be upset because our portfolio didn’t match ‘market’ returns?

Now say we make 30% of your portfolio bond/fixed income holdings and they return just 3%. Now our overall portfolio return drops to 9.4%. We are nowhere close to the 15% ‘market’ return. Time to be upset yet?


Before you react, take a look at the thought that went into creating your portfolio. First, was an analysis done to determine your risk tolerance? As an advisor, we should work with our clients to determine this so we know the mental comfort level you have to ride out the ups and downs of the market (again, see chart above). Was analysis done to determine your risk capacity? We need to understand how long to expose your investments to risk before you need the funds. The longer you can leave them invested the more risk you can take because you have time on your side for any losses to recover. But, if you need the funds in a few years then the mindset switches more to preservation than focused on growth. The combination of these two items will help determine the proper allocation of your portfolio and how much risk you can take on (i.e. stocks vs fixed income). You might match market returns but if you lose sleep every time the market goes down 1% in a day then being 100% invested in that index is probably not a good thing for you.


Next, is your portfolio well diversified? In our example above we talked about having your entire portfolio in one S&P 500 index fund. Again, no one is going to advocate being all in on a single fund. We want to spread our investments around to different sectors and segments of the overall market. As a result, we add in some mid and small cap funds, throw in some International and Emerging Markets. Maybe you even dedicate a little chunk to a dedicated area (tech, healthcare, ESG, etc..). We do this to cover our bases. In our example, the S&P 500 was up 15% and International was only up 5%. But how would you have felt in 2016 when the S&P returned 9.5% but the small caps returned 18.2% and small value returned 24.6%? Bet you wished you would have been invested in something other than just large cap that year. Nobody really knows what exact date a particular segment of the market will take off or when it will cool down so by being in a little bit of everything at all times you are always participating in what is working, and on the flipside, what isn’t as hot. This works to smooth out the average portfolio return.


The fact is that once you construct your portfolio to be diversified and have the proper

allocation there is no way you can compare your rate of return to a single market index. You’re just not comparing apples to apples at that point.


Instead, try thinking of your returns in a different way. Instead of comparing your rate of return to a certain benchmark try tracking the progress you are making towards your goals. As an advisor, I never work with a client and have a stated goal of returning 12% on investments. Instead, the goal the client might really care about is to retire at a certain age. When I meet with a client we review how we are tracking towards that goal, what possible challenges could prevent them from achieving that goal, and are there any changes we need to make to the plan. Over time we track the progress towards achieving this goal and make sure we are heading in the right direction and course correct if we are not.


For example, if the client is at age 48 and we show a 70% chance of success in achieving that goal, assuming a 6% average return in a portfolio that is 60% equities and 40% fixed income, it would appear we have some work to do here to meet our goal. To increase our chance of success we may need to bump up the portion of the portfolio that is in equities to say 70% which will increase our chances of having higher overall returns. Maybe we can see if they can increase the amount they are saving for retirement. Maybe the answer is a combination of the two. There are a lot of different levers we can pull to get to that goal. The best solution will depend on what makes sense given the client's specific situation and comfort level. As time moves on, let’s say at age 58, they now are at a 97% chance of achieving their goal. Obviously, the client is in a very good position now and there is no reason to take unnecessary risks that might result in missing a goal we are so close to achieving. Here, we might be perfectly happy with that 6% return even if the market returns 20%. Why? Because the risk to get the extra return isn’t worth the downside of screwing up obtaining their goal. Sure, maybe we could have added an extra $50,000 in returns by having 75% of the portfolio in equities but if the market took a downturn that year we would have increased losses and now retirement at age 64 could be a challenge.


The bottom line is there is no magic number you should be tracking against for your portfolio returns. Don’t worry about your brother, co-worker, or friends and what they are doing. As we mentioned earlier, they may mention a specific move they made that gets you doubting yourself but you don’t know how many times a similar move went against them or how they are tracking towards their long term goals. Your portfolio needs to do what you need it to do to meet your goals. There is an obvious emphasis on focusing on you here. If you are on track to achieve what you want to financially out of life that is all that really matters. You can go to bed and rest easy dreaming of the life you want.


Thanks for reading and hopefully you found this informational. As always, I love to hear any thoughts or questions you might have. Please email info@7thstfinancial.com and let me know what is on your mind.




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