Fixating on investment returns can be a fool’s game, especially when considering numerical realities
When people start building their nest egg, it usually involves taking some of their money and making it work for them in the stock market, typically through investment funds. But in their eagerness to ensure they make successful investments, they could be committing a basic error — by fixating too hard on performance.
As observed by an article on Barron’s, retirement savers who watch the stock market closely can get exposed to daily updates on major benchmarks like the S&P 500. In a situation where the market goes up 20% a year, even a respectable 10% return on investment can seem like a failure.
“It’s one of those things where I tell people to be careful what you wish for,” Patti Brennan, certified financial planner and president of Philadelphia-based Key Financial, told Barron’s.
In meetings with new clients, Brennan asks them to identify themselves as either “outcome-driven” or “performance-driven.” Outcome-driven individuals aim for a return based on their investment needs and risk tolerance; those who are performance-driven tend to be conscious of an often-arbitrary benchmark, and whether they can match or beat it.
Such a focus on performance seems harmless on its face, but it can actually set clients up for disappointment. One common mistake, Brennan said, is the tendency for those investing in a specific index to expect to match its returns, even though they are pursuing a dollar-cost averaging strategy.
“Even if you had 100% of your money invested in the S&P 500, your performance will not be what the S&P 500 did because not all of the money was in that account the entire 12 months,” Brennan said.
There’s also the oft-cited axiom, applicable in physics as well as investing: what goes up must come down. Many do not realize that a steadily rising market is the exception rather than the norm, and that portfolios that suffer a loss of 10%, for instance, would require a subsequent return of more than 10% to break even.
Of course, a lot of people quit while they’re behind; rather than stick with a pre-determined investment program, they abandon ship. It could be a wise decision when all signs point to an imminent bear market. But as evidenced by research from Dalbar, which showed that the average US-based investor in an equity fund lost twice as much as the S&P 500 in 2018, it’s easy to mistime the market.
Performance anxiety can also be difficult when one compares different investment fund vehicles. ETFs, for instance, continue to gain favour among investors, but selecting one based on a comparison of different alternatives can be challenging due to a lack of standardization in measuring performance.
Given those drawbacks, adopting a performance-based mentality may not be as important as being on the right financial track. This may be hard to explain to clients during market downturns, especially as concerns over longer lifespans and extending financial support to other generations continue to loom large — though it could be easier when their portfolios are properly diversified.
“A good portfolio is like a garden,” Brennan said. “When it’s truly diversified, something is always in bloom.”
