Singing the investment returns blues? Your investment returns aren’t performing as well as you planned? Does your Morningstar investment rating show 5 stars, but your actual investment returns only show 1 star?  You might need a better investment returns recipe!

Not too long ago, I looked at a client’s portfolio and found a gap between the expected returns and the actual returns. I asked how this client developed return expectations. The expectation came from reading a previous returns sheet, which suggested a high star rating. This is called track record investing.

The problem with this type of investment strategy is that it focuses on the past. It involves attempts to assess which superior-performing investments (from the past) will continue to be superior in the future.

Remember, superior investment returns can only be identified as superior after the returns have occurred! This is even more challenging in a 401(k) or 403(b) plan that’s already screened the universe down to a small number from which this client could choose.

How many investment returns do you need?

I hear from 401(k) investors that they “hope to make as much as possible,” or simply to “make money.” These two approaches don’t specifically address the issue of risk.

While some hate the word risk, I am unaware of an investment that exceeds inflation that does not have risk. Even insurance companies, sometimes providing a guaranteed return, have a disclaimer that says: Subject to the claims-paying ability of the firm. Yes, insurance companies do go out of business.

Why not start with the question of how much return you need?

That starts with planning. Questions that should be answered:

  • What is the goal?
  • When do I want to reach the goal?
  • How much can I save?
  • This approach limits the need to take on excessive risk. Why take on risk where there is no need?
  • How much risk do you need to take?

Yes, I said it. Risk.

There are many forms of risk!

There are many forms of risk. The risk of a bad advisor, a bad investment, a bad market, a bad sequence of returns, the risk that rising prices outpace the growth in your account, and the risk of targeting too little or too much return.

When it comes to investing, you are often given a benchmark. The popular benchmark is the S&P 500. Often US investors use the S&P 500, a measure of the returns of the top 500 US companies. This is one way for an investor to determine if the investments they choose to sink their money into are performing well. While you can choose to invest in all 500, many investment advisors say they can do better. Tracking error is a way to determine if they matched their bravado.

While often quoted, it is often misused. For example, if you have investments such as bonds in your portfolio, it would be wise to compare your returns to a comparable percentage of bonds. You may use the MSCI Bond Index or Government Bond Index, depending on the returns you want to track. We’ll discuss that in a future blog.

Investment returns, better recipes, or better ingredients

Some investors choose to focus on fine-tuning the recipe. That is the approach I use. A friend of mine’s mom owned a restaurant. My parents said it was the best Italian food they ever had. One day they let me go into the kitchen. I was shocked to find out that they were not using the finest ingredients. Their focus was on great food at a reasonable price. Apparently, paying more for ingredients to use in Grandma’s recipe was not their ticket!

You can frequently find recipes on the boxes of the ingredients that you buy. The ingredients call for generics, like salt or sugar. However, the manufacturer of the brand you selected also specifies that you use their brand for that needed ingredient. What if you used the generic rather than the name brand? Would it change the taste?

In fact, what if you saw food as science? Getting the purest form of one ingredient to pair with the purest form of another ingredient scientifically works. Oil and vinegar, in the right proportions, stirred vigorously, and blended together. You might improve on that by adding a few ingredients. Scientifically vinegar is an acid. You could use another acid, like lemon or lime. You may try this substitution to alter the flavor or save money.

Get recharged with a new investment returns recipe!

I think that starts with a plan to reach a goal that stipulates the investment returns that you need. As investments that carry risk have variability, you should seek the variability or rollercoaster that best suits you! That may mean taking on more risk because you can’t save more or wait any longer, or taking less risk because you don’t want to risk your principal when there is no need to do so.

Finding a pattern of returns consistent with not feeling on edge will go a long way to letting time and markets do their thing. Besides that, you should focus on what you can, control-saving and time (God willing). If you want to learn about an approach based on 90+ years of financial science, let us know.  You can find this information in various textbooks, as well as on Google if you know the right search terms.

The opinions expressed in this article are to provide general information, and not intended to provide specific advice or recommendations. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested directly.

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