Investment Returns
When Do They Make Sense?
Always. That is the short answer to the question: when do investment returns matter? But without context, that lacks meaning. For different investment options, they may be the guaranteed rate of interest or average historical returns. With traditional best practices, returns are expressed as percentages and compared with market indexes.
This is useful to a point, but for objective investors, it is just the beginning. The primary purpose of investing is to earn a rate of return that is positive - which also means to safeguard the asset’s conversion value to goods and services. And those two aspects imply risk, which must be considered with an investment’s return potential. But in the retail and trust world of personal investment, risk and reward are not well understood or used in the best ways.
For variable investment vehicles such as stocks, bonds and commodities, their actual historical returns are compared to certain benchmarks and against each other to identify market outperformance and superior management skills. In addition, variable returns are expressed as predictions about future market performance – and these are based on economic forecasts (macro), earnings projections (micro), relative valuation (quantitative), moving averages (technical), or recent history (regime-based).
For objective investors, none of those are relevant. The future performance of capital markets cannot be predicted or controlled - and all of that ignores the risks and returns that matter – dollars of future wealth. When the performance benchmark is changed to your life as the investor and you minimize the risks that you know and can control, investment returns start to make sense.
But only in the context of your personal goals and the risks that you can control. First, we set aside all of the risks that are discounted by the price mechanism of markets and focus on the others – and they fall into two categories: controllable and probabilistic. Those we can control include spending, underperformance, assumption errors, concentration, and liquidity risk.
The next step is to balance those against the uncertainty of the future – and that includes market risk exposure, sequence of return risk, and longevity risk. Ultimately, this leads to the performance benchmark that matters; dollar-weighted returns.
Think of it this way. The head of product development at a Wall Street asset management firm will measure returns based on cash flow – meaning fund flows to their ETFs, mutual funds, and fiduciary accounts. That is their performance benchmark. And for the individual investor, the benchmark is also cash flow, but in dollars of future wealth.
The standard is their personal goals and the life-enhancing objectives those serve, which are the subject of the next essay. So, when do investment returns make sense? When they are dollar-weighed, forward looking, and balanced with controllable risk. To learn more, please click the link below:
https://www.amazon.com/Moneyball-Method-Middle-Class-Manifesto-Objective/dp/1696009111/