We ask a lot of questions before developing an investor policy statement for our clients and one of them is about their rate of return expectations.
But we don’t ask with the intention of developing a portfolio designed to achieve those expectations. So why bother asking?
Well, we ask to get a sense of how much, and what type of client education will be necessary when we present the optimal portfolio.
One of the things we might discuss is the impact of volatility on returns. Here is a theoretical illustration to prove the point:
Beginning investment $100,000
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 | Average return | Accumulated Value |
| Portfolio A | 6% | 6% | 6% | 6% | 6% | 6% | 6% | 6% | 6% | 6% | 6% | $179,085 |
| Portfolio B | 15% | 15% | 15% | 15% | -30% | – 10% | 0% | 15% | 15% | 15% | 6.5% | $167,580 |
Now, we realize that these numbers are constructed to illustrate the point, but the point is an important one nonetheless.
Individuals seeking double digit returns will typically purchase the Portfolio B investment in year three or four after the great returns have come to their attention. Then they experience the declines of years five and six. Typically, by year seven a number of them will decide that it wasn’t such a good investment after all and sell at a loss. With this kind of volatility, most investors don’t hold on long enough to receive the average 6.5% rate of return. And the bad news is that even if they were invested for the full 10 years, the 6.5% average gets them less money at the end of the day than the boring portfolio that generates 6% each year.
The bottom line is that volatility and sequence of returns matter. More on both of those subjects to come.
Stay tuned.
Rona Birenbaum is a certified Financial Planner and is licensed to do financial planning. Rona is registered through separate organizations for each purpose and as such, you may be dealing with more than one entity depending on the products purchased. Rona is registered through Caring-for-Clients for financial planning services. This website is not meant as a solicitation for financial advisory services. Financial advisory services are available through the facilities of Queensbury Strategies Inc. Financial Planning is not the business of or under the supervision of Queensbury Strategies Inc. and Queensbury will not be liable or responsible for such activities.