Metric analysis

Are you comparing your retirement investment returns to the right metric?

I often hear people talk about “good returns on investment”. What is a “good” return? Does it just mean a return that is not negative? But can this really mean that yields are compatible with a person’s values? Let me explain.

In my role as a professional CERTIFIED FINANCIAL PLANNER, I usually qualify the return on investments by a combination of risk and return. This requires looking at returns over a long-term horizon, such as 10 years or more. This allows us to observe the movement of a particular investment, including an average number and the magnitude, or change, of those returns over time.

For example, an average return of 5% may have seen returns range between -15% and 25%. In this context, is a 10% return “good?” Is -10% “bad?” When I talk to most people, they judge their returns to be good when recent returns, say a quarter or a year, are positive returns.

Many people think that investing is about hoping for the best. Movies and TV shows often show the speculative side of investing. That’s when you get a good feeling, perhaps based on research you’ve done on the company or industry, and decide to invest. This mindset is more appropriate for building discretionary wealth, but not for generating monthly income in retirement.

Default investments in 401(k) plans, target date mutual funds, balanced funds and asset allocation funds are based on this philosophy of risk-adjusted return. Charles Self, former Chief Investment Officer at iSectors, says: “You can only manage the risk, not the return.”

Your employer may use a balanced fund or other asset allocation fund as the company’s default. These funds are often made up of a static allocation of 60-40% stocks and 40-60% bonds. Target date funds are made up of similar allocations, but the proportion of stocks to bonds changes over time depending on the mutual fund’s strategy.

What is your investment target?

Many people aim to make money. It could just mean putting your money in a savings account.

Another approach is to complete a risk questionnaire to assess your risk tolerance. Most of the time, these give no real insight into your comfort with market declines, which is the true measure of risk tolerance.

Risk questionnaires typically offer some mix of stocks and bonds, framed by emphasizing long-term expected returns. They rarely, if ever, give the investor insight into the expected bumps in the journey to achieve those returns.

I think the best results come from calculating the yield you need to reach your goal based on your own timeline. When it comes to investing for retirement, this should involve considering factors such as:

  1. How much do you want to spend in retirement.
  2. What healthcare and long-term care costs might you face.
  3. When you will take Social Security and its expected value.
  4. Will you receive pension income there?
  5. How much are you ready to save and when do you expect to retire?

After considering the factors that apply to you, you can determine the rates of return and their volatility that you must achieve in order not to run out of money.

Appropriate investment comparisons*

I believe that one of the comparisons needed to judge good performance is a proper benchmark. The Standard and Poor’s 500 (S&P 500) is often quoted. That’s not an accurate comparison for most people, though, especially those investing for retirement. If you were in the S&P 500 during the Great Recessionyour money would have gone down about 50% if you had left it in the market.

However, many people withdrew their money from the market because they did not see the expected returns. If we looked at the S&P 500 over decades, we would have seen that it is volatile. However, we tend to only remember it when it’s in place; it seems that it is a little as if the mother forgot her childbirth.

Vanguard offers an S&P 500 mutual fund that replicates the S&P 500 index. In this case, the S&P 500 index is a great benchmark. You should understand that the index returns will be reduced by the fees charged by Vanguard and your advisor.

Vanguard also offers the LifeStrategy Fund Series which provides static combinations of stocks and bonds ranging from 80% stocks/20% bonds down to 20% stocks/80% bonds. Let’s take a look at the results of the LifeStrategy Moderate Growth Fund (VSMGX).

The VSMGX fund is made up of four other Vanguard funds:

  • 36% Total Stock Market Index Fund;
  • 28% Total Bond Market II Index Fund;
  • 24% of the total international equity index fund; and
  • 12% Total International Bond Index Fund/Total International Bond Index Fund II.

According to their website, as of July 1, 2015, Vanguard compares the VSMGX fund to a portfolio consisting of:

  • 36% CRSP (Center for Research in Security Prices) U.S. Total Market Index;
  • 28% Bloomberg US Aggregate Float Adjusted Index;
  • 24% FTSE (Financial Times Stock Exchange) Global All Cap ex US Index; and
  • 12% Bloomberg Global Aggregate ex-USD Float Adjusted RIC Capped Index.

While Vanguard offers investors the ability to invest directly in the S&P 500, this is not explicitly listed in this asset allocation.

From a risk and return perspective, consider…

What does risk mean in this context?

Let’s look at the 10-year risk figures. While the Fund’s annualized return was 8.10%, about 95% of the time these returns ranged from -14.33% to 26.99%. If you do the analysis on the other periods, you will not obtain exactly the same results. In fact, past returns may not be what you will get in the future.

This analysis attempts to give more meaning to the first table which gave the annual results for each period. The monthly and daily returns of the investments that make up their annual rate are not given. The risk and return numbers attempt to give us an idea of ​​how difficult the ride is.

If you invest moderately (60% stocks/40% bonds), how does your portfolio compare to Vanguard’s benchmark?

Are your values ​​integrated into your returns?

I frequently hear people comparing or complaining about racial and gender inequality issues in the corporate world. Do you know how the companies you invest in, through your mutual funds or exchange-traded funds, score on these questions?

There’s an argument that if companies do well on equity issues, you wouldn’t make as much money in your investments because companies pay more money to their workers.

There is another argument that says that by paying workers more, companies will get better quality workers, ultimately providing better products and services. I think it’s a choice of values! You might want to check out the many articles I’ve written on integrated securities investing:

Are you unknowingly investing in private prisons?

Can women really succeed in retirement by investing in gender equality?

Can women really retire comfortably with index investing in gender equality?

Do you want to retire investing without fossil fuels?

Do you want to retire without deforestation?

What do your cause-adjusted returns look like?

Final Thoughts

It is imperative that you have specific numerical targets for your required rate of return, but preferably for risk and return. This is the best way to judge if you have superior performance. It can be easy to want to switch to another investment when you hear about its returns. However, what is its risk?

This can be assessed by understanding its benchmark. And, just because something says “conservative” on the label, does that actually fit your definition or some other mutual fund company’s definition? Benchmarks can help you with this assessment!

It is important to know what to expect during your investment journey. Because your trip will be unique to your needs. It helps to know what type of turbulence to expect. You don’t want to bail out for the wrong reasons. If a new opportunity arises with less turbulence, but the same expected return, it may be worth changing flights. If not, you need to stay the course.

*Reference to Vanguard funds or the Vanguard LifeStrategy Moderate Growth Fund is not an investment recommendation. It has been used for illustrative purposes.