Tuesday, May 28, 2019
Investing is About Goals, Not Performance
Most of my clients have no clue about how the stock market works. Stocks, bonds, ETF’s, Index Funds, Bitcoin, Marijuana, it’s all just a bunch of noise. I personally follow the markets closely and have far better knowledge than the average person. Despite this, the scary truth is none of us really know what’s going to happen. I equate it to sports. I am a huge NFL football fan. I love the Sunday ritual of watching games with friends, joining pools and leagues and comparing results with hopefully bragging rights to follow. I watch all the pregame shows and watch the experts make their picks for the day. Analysts, former players, and coaches with inside knowledge of the game, and even these guys can’t beat the 50% efficiency mark. My grandma picks games about as good as they do based strictly on the mascots alone. The market is the same thing. A bunch of headlines and talking heads trying to find the next big thing, all the while missing as much as they hit. So, what do we know? Are we gamblers, or investors? The average person doesn’t care about bitcoin or the cannabis industry. They care about putting their kids through college, buying a home, and retiring comfortably. The average person cares about achieving their goals, so let’s focus on that. Let’s take a trip in time, all the way back to 2008.
The Industry Standard
The investment industry has been based on several key factors since the dawn of time. Active management (mutual fund managers and their brokers), try to outperform the market. The problem is that even if this is achieved, problems come into play. A glaring example is 2008 and the chaos that ensued. People saw their retirement nest eggs depleted by as much as 30%. It was a nasty pill to swallow for most. Where the problem lies is that the fund managers that saw a -15% performance were the winners. They technically did outperform the market. Why is this a problem? It is an issue because outperforming the market is not what most investors are looking for. I have not had one client come to me and say they want a 10% return, or they want to be a shade higher than the TSX index. I have had many come and say I am worried about having enough to retire on. That broker or manager who outperformed the market in 2008, while winning with some, still lost with many others.
A pushback on active management occurred. “This guy has been managing my money and under his watch, I lost 20% of my retirement savings.” I get it, it sucks. So, what do we do when this happens? We step back and blame the car that got us there. The years following 2008 you see the rise of passive management with ETF’s and Index Funds gaining popularity. These low-fee solutions follow the market closely without beating it or significantly losing to it. “If my guy couldn’t save me in 2008, I might as well just deal with the market on my own.” The problem is that this doesn’t fix it either. We still have not determined what is the best route to reach our goals. While we are currently on the longest bull run in market history, recent volatility has everyone thinking of the “pending crash.” I guess that is the nature of man. Pessimism in good times and bad. How do we get to a point where the “crash” doesn’t affect our goals? What’s the solution then?
It’s getting silly. It’s getting confusing. It’s getting out of hand. What do we do when things get like this? Back to basics. Why are we in the game? We want to achieve our goals. The money and growth are just a means to an end. Again, I have had not one client come to me and say they want to be invested in the Tactical Emerging Market Growth Fund. We want to retire on time and live comfortably throughout. What do we need to do that? Let’s say 50K a year in retirement is the goal. There is X amount of years until our desired retirement date. This means we need X amount of dollars on that date. In order to achieve that goal, we have to put away X amount of dollars per month. We also need to achieve a certain rate of return on our money. This is where it gets interesting.
Logically, the better the rate of return we get, the less we must save to achieve the goal. Also logically, the more we are saving, the less we will rely on performance to achieve our goals. I see a little chicken and egg thing going on here. What if the solution is not to pick funds based on rates of return and instead, they are picked based on your current situation (budget) and your desired outcome?
Here’s an example:
You are currently saving $300 a month towards retirement. Your goal is to live off 50K a year in retirement, and you have 25 years to save enough money to do so. The problem is that with the current savings level and rate of returns you are getting; you will fall short of this goal. Your choices are:
- Live off 47K annually in retirement instead
- Save $350 a month for the next 25 years instead
- Deposit a lump sum of $72,000 in your retirement accounts
- Instead of the 5% rate of return, you are getting, up your risk tolerance to achieve 7%
Well, we don’t want to live off 47K a year in retirement because that means no trip down south every year. I also don’t have 72K to throw into my accounts right now, so that’s out. What I can do is save a little more every month, but also try to achieve a better rate of return. The saving part is easy, but what about the rate of return. Instead of a fund manager or broker telling you what to invest in, a sophisticated computer model can adjust your asset allocation slightly to achieve this goal. What does that mean? Before, my industry based your asset allocation on several zones. Conservative, Moderate, Balanced, and Aggressive may come to mind. As a balanced investor, you may think a 60-40 split between equities and fixed income is the way to go. This may not get you to your goals, however. Even worse, your advisor might not even know it. Adjusting that 60-40 split to 70-30 could be the ticket to achieving your goals. As smart as I am, finding that right mixture can be difficult. This takes the guesswork of picking funds out of your hands and the advisor as well, which they should be quite happy about.
So why Goals?
Let’ go back to 2008 for a second. Let’s just say you had $1,000,000 invested in 2007 and it was your goal to retire in a year. This money was your entire nest egg and it is just enough to get you and your family through retirement. Your advisor decides that a Moderate portfolio would be good the next year, as you can’t be too risky. Sadly, when the markets crash, you lose 10% of your nest egg. Your advisor touts how everyone in the market lost 30%, while you only lost 10%. This gives you little solace as you now may not have enough money to get that fishing boat you wanted or visit your family back home every year. Leaving a goal this lofty up to chance is not in anyone’s best interest. When you focus on goals, the answer becomes much clearer. Preservation was the goal, so showing a portfolio based on the income in retirement and funds that would preserve your nest egg was what mattered. At the end of the day, does it really matter how we get to the finish line, or does it just matter that we get there?
What’s the Outcome?
What comes of this kind of system is simple. Planning is based on what you want to do in life and what it will take to get there. If you want to retire with $1,000,000 and you reach that goal, would you be upset if you achieved a 7% return during those years instead of a 10% return? I wouldn’t that’s for sure. The average person doesn’t have millions of dollars to throw around. The average person can’t take a 15% hit near retirement. The average person doesn’t want to see the sausage made, just throw it on the grill. Do the right funds matter? Yes of course. But finding the mixture to help you achieve your goals is difficult and we all know how difficult it is to outperform the market. What we want to know is that we are on track to achieve our goals, and to have this progress monitored along the way. That’s what matters.
When you go looking for assistance with reaching your goals, make sure that the conversation is solely based on that. In my industry, you live by the sword and you die by the sword, the sword being fund performance. A better way to live would be to save the right amount, get a reasonable return on your money, and track your goals as the years go by. Whether it’s putting the kids through college, saving for your first home, or planning your retirement, it’s the goal that matters. It doesn’t have to be supremely complicated and always be wary of someone who presents it that way. In my experience, the more complex someone makes a subject, the less they know what they are talking about.
“When it is obvious that the goals cannot be reached, don’t adjust the goals, adjust the action steps.” – Confucius
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