Once in a Lifetime!
A common question I get asked when talking with new potential clients is what kind of return can I expect if we work together?
This is a reasonable question for someone to ask. But it’s also a question that any good financial advisor should answer without giving any kind of real number. We can share the strategies we use (for me it’s a lot of low cost Dimensional Funds, Vanguard Funds, and others) and the track records of those strategies are easy to look up, but those track records will look almost nothing like any new investor’s experience.
The reason?
Because you will have your own once-in-a-lifetime experience with investments (unless there is a guarantee associated with the strategy someone is recommending).
Public Service Announcement: investments that guarantee a rate of return in advance are almost always either deceptive products with restricted liquidity, or have a guarantee that is very low.
For now, let’s focus on why you’ll have your own once-in-a-lifetime investment experience:
Reason #1: Your savings will be lumpy and relatively unpredictable.
You’ll get an unexpected bonus or pay cut.
You may receive an inheritance.
You may receive some unplanned stimulus payments or tax breaks from the government.
Etc. etc. etc.
Life is hard to plan around and the expectations we had 10 years ago didn’t play out. Neither did the ones we had 10 months ago. And look at you now, even 10 minutes ago you couldn’t have predicted that you’d be reading this blog right from me, right?
The timing of these unexpected events is important. This is why we make a plan, let some life play out around us, revise our plan, repeat.
Practical Tip: If your life was good before that unexpected cash inflow, then keep living like you didn’t receive it and invest the cash or pay off debt…. Or at least do this with a large part of the windfall and spend the other part.
Even though savings can be lumpy, a high savings rate is important at all times. You see, if the unexpected event is a negative thing like a decrease in income —but your savings rate is high— then you have a large insulation against a pay cut being able to impact your daily life. Instead, a pay decrease first means a savings decrease before it means a lifestyle decrease. Being able to save less is easier than being forced to trim expenses. Both might be necessary, but having a high savings rate allows for some breathing room.
Reason #2: You’ll make some unplanned withdrawals from your portfolio.
Your kids or grandkids may need some education funds.
You might move to a bigger house or buy a vacation home.
You might have to dip into your investments to replace a loss of income or to manage unexpected inflation.
No matter the cause, the requirement to sell investments for things you want to accomplish is something that affects portfolio rate of return in a way that is truly unique to you.
The Market doesn’t always cooperate with the timing of your need for funds.
Practical Tip: Forecasting withdrawal needs is so important when it comes to marrying a portfolio strategy with a financial plan. The most important parts of this forecast are (1) when the funds will be needed and (2) whether or not you can be flexible about needing the funds.
There’s a saying that goes “It’s not timing the market that matters, it’s time in the market that makes a difference.” This is important because short term market forecasting is not a prudent way to invest (no one can do it consistently well). However, when you give yourself a long time to invest, the ups and downs of your investments don’t matter as much; history is a great example of this. When you have a flexible need for funds (like, you just decide not to buy a Ferrari that you didn’t really need), then you can also ride out the ebbs and flows of the market.
Let’s look at an example.
The chart below shows the price movement of the SPDR S&P 500 ETF (symbol: SPY) over the course of 2020.
Yahoo Finance. Past performance not an indicator of future performance.
Consider a hypothetical investor last year who had to withdraw $25,000 from their portfolio consisting of 100% of this fund. For the sake of argument, let’s say this investor has a cash need and pulls funds out on March 23, 2020, i.e. the worst day to sell last year (the big dip on the chart above).
They didn’t just spend $25,000, they also missed out on the opportunity to have that $25,000 become about $42,400 by year-end. You see, flexible investors are able to consider opportunity cost when deciding whether or not to pull funds from a portfolio. If it looks like a bad time, they don’t need to sell.
Investors can be more flexible by having a low cost of living, which often means no debt. They can also have a large emergency fund to cover the unplanned things or to account for sub-optimal market conditions to be selling investments to buy stuff. Finally, they can adopt some investment strategies in their portfolio that are not designed to produce long term growth, but instead are there to aid in these potential withdrawals if the timing is poor for selling stocks and real estate.
Reason #3: You’re going to make some bad emotional decisions.
You might make a split-second decision to buy a new car rather than drive the old clunker and invest.
Perhaps you bought into a time-share and can’t get out of it.
Maybe you sold after investments declined because you thought things were going to get worse.
These are all normal things people do. If you’re normal, you’ll do a few of them too.
Practical Tip: Clearly I’m biased, but this is one area where I think an advisor’s objectivity as a sounding board can be valuable. The fact that I’m not you remains perhaps one of the best advantages I have to evaluate problems. This is also a reason why I routinely run my own financial decisions by industry colleagues — advisors are human too and we need guidance from third parties.
Reason #4: You’re going to get lucky.
Perhaps you’ll get an influx of cash right as markets pull back; enabling you to buy at lower prices.
Your peak savings years may align well with a bull market.
Your 12-year-old niece may tell you that the Tik Tokkers are dumping money into AMC Theaters stock and you decide to put in $10,000 into the stock at the beginning of 2021 and it turns into this…
Okay, maybe you won’t turn $10,000 into $123,208 in 5 months like the hypothetical Tik-Tokker above, but you get the point: Some things will go better than expected.
Okay, maybe you won’t turn $10,000 into $123,208 in 5 months like the hypothetical Tik-Tokker above, but you get the point: Some things will go better than expected.
But some things may also go worse than expected. In the chart below, you can see the yield on CDs (Certificates of Deposit), which are considered safe investments.
Look at the returns you could get from your savings strategy in the 80s. Wow, some might call that lucky for people who were good risk-averse savers with little or no debt.
But some may also consider today’s risk-averse savers to be unlucky as the yield on safe investments is essentially 0%.
But there’s another side to this. When safe stuff pays a lot, borrowing to finance your lifestyle punishes you.
Consider this:
Mortgages were extraordinarily expensive at the same time that safe investments yielded the most. Imagine having a 17% APR on your mortgage. Yikes!
So depending on where you’re at in your life, you may get paid more or less to be risk averse investors or you may get charged more or less to borrow money. Luck is a big factor.
Practical Tip: Lucius Annaeus Seneca, an ancient Roman philosopher, originally coined the phrase "luck is where preparation meets opportunity”, and I think that is a very appropriate quote to consider at this point right now.
As investments are concerned, we’re currently at a place where we need to continually prepare for and embrace volatility if we want any kind of shot at growth. As you know, your safe savings accounts don’t pay anything, so if you want to keep pace with inflation it’s going to require risk-taking. Those who are well-prepared to handle the ups and downs of a riskier portfolio are better positioned to take advantage of the long term opportunity offered by riskier investments (more risk traditionally = more return potential).
*Not investment advice ;)
Lastly, it’s just money. Spend it with the above in mind.
That’s all for today.
Onward,
Adam
