Expectations, Reality and Maybe a Little Math: Financial Goals vs. Investment Returns

Here and Now sign

Most people who are interested in working with Woodward Financial Advisors express a desire to talk about a variety of topics related to their financial lives, which fits perfectly with our goal of delivering comprehensive wealth management advice. I received a phone call from a prospective client that was a little different late one Friday afternoon (already a dubious sign).

The caller started the conversation by saying he had money to invest and was interested in full-service investment management. Already I saw some potential “red flags”, sensing someone who was solely investment-focused as opposed to being financial planning-focused. My suspicions proved accurate when the caller went on to say that he was: looking for significant returns in the realm of 10% per year; expected to outperform the S&P 500; and intended to double his investment in 5 years, as that was when he intended to retire.

Honestly, I thought one of my financial planner friends was playing a practical joke on me. I wasn’t even sure where to begin. As long-time clients can attest, all three of the caller’s expectations were in contrast to Woodward Financial Advisors’ core investment philosophies.

First, the caller wanted to double his investment in 5 years while getting returns in the range of 10%. There’s a handy little math trick called the Rule of 72 that you can use to estimate you how long it might take to double your investment: divide 72 by your rate of return, and the answer is about how many years it should take. So with a 10% return, it would actually take 7.2 years to double his money. If the caller really wanted to double his money in 5 years, he would need an annual return of about 14.4%.

That’s a pretty tall order that could probably only be achieved with a very aggressive, all-stock portfolio, which brings us to the second issue: the time frame. If a specific dollar amount is needed within 5 years, putting it all in the stock market is simply too risky. It’s true that the average annual return of a 100% stock portfolio[i]  from 1926 – 2013 has been just over 10%. But over that same time frame, rolling periods of 60 months (i.e., 5 years)[ii] had negative returns 13% of the time, and the lowest compound annual return over a 5-year period was -17.4%. While things have historically turned out ok, those odds just aren’t good enough to justify an all-stock portfolio for such a short time frame.  And in all likelihood, an annual return of 14.4% would likely require a portfolio made up of things that are much more volatile than large US company stocks, thereby increasing the probability of less-than-desired outcomes.

Lastly, the caller expressed an expectation of outperformance, particularly over a short time frame. I’m sure all of us would love to magically have our investments do better than the market every single year. Unfortunately, there doesn’t seem to be a way to consistently pull that off while staying out of prison. For example, Dimensional Fund Advisors looked at the stock mutual funds that successfully outperformed their benchmark from 2007 – 2009 and then examined their subsequent performance from 2010 – 2012. Of the 1,189 “winning” funds over the first 3-year period, only 26.4% continued to outperform their benchmark over the next 3-year period.[iii]

In good conscience, I informed the caller that I didn’t think there was any way we could help him achieve his objectives.  Any honest financial advisor should have done the same.

But beyond these three elements, perhaps the most challenging element was that the caller never really said why he needed to double his investment. We’d much rather approach the issue from the starting point of how much the caller needed to spend in retirement. It’s possible that he didn’t really need to double his investment, depending on his long-term goals. But because he’s starting from an investment point of view with a dollar amount goal, we’ll never get to have that conversation.

At Woodward Financial Advisors, our approach is much more goal-centric, with a foundation of realistic expectations around time frames, investment returns, and accompanying risk. Going forward, the approach may also include not taking phone calls from strangers at 4:50 on a Friday afternoon.


[i] Represented by the Standard & Poor’s 90 index from 1926 through February 1957 and the S&P 500® index thereafter, which is an unmanaged group of securities and considered to be representative of the U.S. stock market in general.

[ii] Rolling period returns are a series of overlapping, contiguous periods of returns. For example, when examining 12-month rolling periods, the first rolling period is January 1926–December 1926, the second is February 1926–January 1927, the third is March 1926–February 1927, and so on.

[iii] The Mutual Fund Landscape, Dimensional Fund Advisors (2013)

About Ben Birken

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