What Will My Return Be?

April 25, 2018

Written by Nathan Erickson, CFA®, CAIA, Partner and Chief Investment Officer

 

When we at MRA Associates are interviewed by prospective clients, they often ask “What kind of return can I expect?”  In some cases, it is the only question that matters to that person. He or she is effectively shopping promises, interviewing a number of firms, and will likely hire the one that offers the highest potential return.

This approach is riddled with problems. First and foremost, it assumes that one’s circumstances are irrelevant. We know this is not true. A critical part of the discovery process is understanding one’s risk tolerance. You may want a high return, but if you are unwilling to accept the risk that accompanies high returns, you probably shouldn’t invest in that portfolio.

An additional concern is that promising a return implies certainty. It gives the false sense of security to the individual that he or she will actually experience that return. I struggle to identify another industry where a consumer or investor poses the same question. Consider this… Do you ask your realtor what your house will be worth next year? Or in five or ten years? Have you ever bought a piece of art and asked the seller what it will be worth in the future?  Have you invested in anything where you expected a level of certainty around its future value? Yet investors do this with their investment portfolios all the time.

In some ways, access to real-time data has become a curse for the industry. It allows investors to constantly evaluate their decision making and stimulates regret on a far too frequent basis. I recently read an article regarding market volatility in 2018 in which a number of advisors stated their clients requested to go to 100% cash following February’s volatility. Those clients made a complete change in asset allocation based on one month of performance! Had those clients looked at their statements on 12/31/17 and again on 3/31/18, the thought of going to cash would have never crossed their minds. Yet investors continue to torture themselves with short-term performance analysis.

If investors are willing to have a longer-term point of view, capital market returns are actually far more predictable than most other investments. The longer one invests in a portfolio of stocks or bonds, the more normalized and narrow the returns become. This is even more true for diversified portfolios. Few other investments are like this. Real estate markets can take more than a decade to recover from negative periods, and their longer-term returns can fluctuate dramatically. Art or precious metals are similarly inconsistent. Even my baseball card collection from childhood took nearly 30 years to recover its value, and that’s ignoring inflation!

At MRA we are obsessive about data and statistics. We have estimated future expected returns and risk for all portfolios we build for clients. Those estimates are based on economic principles that drive performance, and they are long-term in nature. They are not intended to provide certainty, but rather to frame expectations. While it is useful information, we hope our clients focus on the bigger picture, where investing is meant to be a long game. If you stay committed to a strategy through the tough moments, you will do quite well in the long run.