Imagine your an investor and you walk into a traditional financial advisor's office. You have a nice conversation about your goals. You discuss things like what it will take for you to retire, how much it might cost to send your kids to college, how much capital it will take to start a business, etc.
Next, the traditional advisor recommends a portfolio and tells you it will help you meet your personal goals. Then the following conversation ensues:
Smart You: What sort of return should I expect?
Traditional Advisor: That’s a great question. Given your age and time horizon this is the sort of portfolio that should help you meet your goals.
Smart You: Of course. I was hoping that would at least be the case. How do I know we are on track? In a year from now, how do I know we are on pace?
Traditional Advisor: Well my crystal ball doesn’t work any better than the next persons. I can’t predict the future, but given your time horizon I think this should give you a good chance of meeting your goals.
Smart You: So you're telling me that I have to just sit back for the next 30 years and hope it works out? So there is no way I can know what to expect year over year?
Traditional Advisor: I understand where you are coming from, but past performance is no guarantee of future results. However, over the long haul a portfolio like this could earn around 8% year over year.
Here’s what happens next...
If you are like most people, you walk out of that meeting and when you reflect back on that conversation you might not remember all that was said, but one thing is likely to stick with you -- 8%.
While that average rate of return the advisor gave you may have been technically correct, there is one major problem.
It is setting you up for an emotional investment experience. One that is prone to end poorly.
The market as a whole may very well have averaged 8% (or more), but do you want to take a stab at how many times over the past 25 years the market has returned exactly 8% in a given year?
In fact, the only time it came within even one percentage point of 8 percent was in 1992 at 7.62%.
Let’s be real. How happy are you if you’re expectation was to average 8% but your year to year experience feels more like a roller coaster? It’s no wonder so many people are wary of investing in the stock market.
Were you wrong to want to know what to expect? Absolutely not. Was the advisor wrong for capitulating and giving you an “expected rate of return”? Not necessarily.
If the portfolio doesn’t meet expectations you are left feeling uneasy and begin to think something must be wrong. And taking a 'wait and see for 30 years' approach doesn't exactly provide warm and fuzzies.
Letting success or failure henge on such a narrow target given the inherent ups and downs of the markets isn’t fair to anyone.