Investment returns vs risk capacity

Cornerstone Investment Services put out a piece a while back that showed the average annual rate of return for the S&P 500 (THE stock market of stock markets) since 1871 is about 5.63% to 5.85%, depending on where you source the raw data from and how you interpret that data.

MOAR:

Vanguard has a report titled, “Keeping Performance In Perspective” where they explain the difference between “portfolio return” (how your mutual funds perform) and “investor return” (how well you, personally, do as an investor).

The difference is striking.

Vanguard measured the fund performance of emerging market stock funds across the industry.

They found the mutual funds performed decently — 7.62%. Investors, however, only earned 5.2% from those same funds.

What?!? Nooooo!

But wait, there’s more!

Cash inflows and outflows also affect investment performance — usually negatively.

Meaning, making regular systematic contributions to savings pulls down your investment returns.

Oh noes!

How do we improve investment performance?

Hold on. I got this.

Save less money. Problem solved, right?

Obviously no.

The extreme focus on investment return usually causes people to chase performance — which is something they cannot control — and ignore the effect of cash inflows and outflows (contributions and withdrawals) instead of focusing on buying valuable assets and investments in businesses — something which they can control.

But… how do you go about doing this intelligently?

First, you assess your risk capacity — how much you can afford to lose for various savings goals.

Most people, most of the time, have a risk capacity of $0 when they first start out.

And, most people maintain a low risk capacity for the bulk of their savings for most of their life for various reasons.

Here’s how that plays out in real life:

If you’re saving up for that shiny new iPhone X, and you need a new phone in 3 months, you can’t afford to risk your savings.

Your risk capacity in this scenario is $0.

Ditto if you’re saving up for a new car or computer, or hopping on a plane to see your dear ‘ole granny before she has her pacemaker put in.

You need X monies by Y date — you can’t afford to lose this money and thus your risk capacity is $0 for this money.

And double ditto if you know you’ll be retiring by a certain age and need a minimum amount to supplement other investment income or… you know you need to pre-fund certain old-age medical expenses before age 80.

Where do you put all this super-important money that you KNOW you need in the future and cannot afford to lose?

In the market?

Uhhhhhh… that’s one place to put it.

But, in my not-so-humble-but-definitely-accurate opinion, that’s a stooooopid idea.

If your risk capacity is low, you don’t fix it by taking more risk.

You fix it by saving up more money and taking less risk until you can afford to take more risk.

Speaking of which, custom whole life insurance is one product where lots of people store lots of cash.

The product is made for low risk capacity folks. Its whole reason for existing is to transfer financial risk away from you and guarantee you a cash value for stuff you KNOW you’ll need in the futrue plus a death benefit if you don’t make it.

But, there’s a right way and a wrong way to get into this sort of product.

A lot of people send me proposals they get from other agents.

I do think I’ve seen it all and… many of them are no bueno.

This business is like a trade. A craft. A dying art.

Any arsehole can build you a house, but only a master carpenter (also rare, by the way) will build a home that will outlast you.

Anywho, if you want craftsman-like work, come join the growing army of email list subscribers. It’s the only way to trick me into working for you.

Or not.

It’s up to you.

David Lewis

This post brought to you by //The Rogue Agent//. David has been a life insurance agent, and worked with some of the oldest and most respected mutual life insurance companies in the U.S., since 2004. Learn more about him and his business, here.

This post brought to you by //The Rogue Agent//. David has been a life insurance agent, and worked with some of the oldest and most respected mutual life insurance companies in the U.S., since 2004. Learn more about him and his business, here.