Investor Returns, not Investment Returns

Those of you familiar with Woodward Financial Advisors have probably seen our Comprehensive Wealth Management handout, which we internally refer to as “The Pyramid.” This handout lays out all the elements of a comprehensive relationship, starting with a foundation of a Net Worth Statement and ending at the top with Investment Design.

We’ll often tell prospective clients that many people want to start out by talking about their investments, which is actually the last thing we talk about. How do we know what an appropriate investment portfolio looks like for a client until we know their goals and other resources? An investment portfolio is an important part of a long-term financial plan, but it’s not the only part.

 Even when we eventually design a portfolio for a client, despite our conviction in our investment philosophy, we know that the portfolio’s success is directly related to a client’s ability to stick with the plan.

 Investor behavior is a much more destructive force in terms of long-term financial success than investment behavior. As the pendulum swings back and forth between unbridled optimism (mania/euphoria/greed) and unbridled pessimism (fear/panic/despair), the average investor typically does the worst thing at the worst time.

 Most recently, this has included loading up on tech and internet stocks in the late 1990s, panic selling during 2001-02 and 2008-09, and, depending on your point of view, buying more and more gold right now.

 But even moving away from the well-known fads, consider for a moment that over the last 20 years, the average equity mutual fund investor didn’t even come close to capturing the return of the broad stock market. According to the 2011 DALBAR Quantitative Analysis of Investor Behavior, over the last 20 years, the annualized return of the S&P 500 Index was 9.14%. Based on the analysis of mutual fund inflows and outflows,  DALBAR calculated that the annualized return of the average equity mutual fund investor was just 3.83%.

 That gap can only be explained by investor behavior, since the person who just bought their boring S&P 500 Index mutual fund back in 1990 and then spent the next 20 years simply living their lives instead of constantly buying and selling outgained their more active counterparts by 5.31% per year. That’s a huge gap over 20 years! Assuming a $10,000 investment, the average investor would have ended up with about $21,205, while the boring S&P 500 Index investor would have ended up with $57,501. Boring sounds pretty good.

One of our main goals as advisors is to help our clients close the gap between their personal returns and the return of their investments. We do that by trying to educate clients about long-term market behavior; designing a portfolio allocation that fits a client’s goals, risk tolerance and time horizon; rebalancing when that allocation is out of line; and not giving in to panic, fear, mania or greed.

 Our investment portfolios may or may not perform better than those of another firm. Frankly, that’s not really something we spend a lot of time thinking about. But we’re pretty confident that our investor clients are going to do pretty darn well in a much more important metric than portfolio returns: achievement of their long-term financial goals.

About Ben Birken

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