My Own Private Island: Sensible Expectations for the Investment Dreamer
Have infomercials ruined us? Has the constant 24/7 media deluge of the global investment markets made us too mad for money? Are the salacious stories of the latest real estate bizillionaire buying their own private island too beguiling to ignore? Seeing everyday couples wave oversized checks in the air, boast about their recent purchases, or having them regale you with stories about their recent get-rich-quick schemes can often lead to expectations about your own portfolio.
All this has an unfortunate effect on some people: we’ve come to expect too much. We think it’s easy to make it big with questionable investment strategies. In fact, we’ve convinced ourselves to expect double-digit profits as the norm. Jason Zweig of the Wall Street Journal aptly summarized most investors’ belief in their market success:
“A nationwide survey last year found that investors expect the U.S. stock market to return an annual average of 13.7% over the next 10 years…in order to earn 6%…after inflation, fees and taxes… investments (must) generate 11% or 13% a year before costs. Since 1926, according to Ibbotson Associates, U.S. stocks have earned an annual average of 9.8%. Their long-term, net-net-net return is under 4%.”
According to this data, investor expectations not only far exceed historical market performance, but the perceived risk of those expectations is minimal. Most investors think they’ll get almost 14% before inflation, fees, and taxes. If you factor in those pesky return-killers, they expect to keep more like 6%.
History suggests otherwise. The stock market’s average long-term net is only around 4%, assuming you follow a very aggressive all-stock strategy. However, considering most investors keep a healthy portion in bonds and cash, the more realistic net return is closer to 2%. Yet people still think they can make double-digit returns more or less automatically.
Eventually investor optimism runs into market reality. Averaging a 14% yearly return is tough no matter how brilliant your strategy. The markets will humble everyone, given enough time. Furthermore, few people manage to stick with the same strategy for long. Whatever we resolve to do on January 1st is usually long forgotten by December 31st.
The problem isn’t with our intentions or cunning. The problem is with our expectations. Making a net return of 6% after inflation, fees, and taxes over a period of years is a massive task for any investor. This is especially true if you’re managing the money by yourself. Don’t fall into the trappings of common investor mistakes.
If you use an investment manager and expect these kind of results, you’re putting the manager in a tough position. Although they may be smart and well informed, it’s nearly impossible to meet such lofty expectations. Professional managers are not miracle-workers.
The best strategy: keep your expectations grounded in reality. Don’t fall prey to the dream of unsustainable or ridiculous returns. Private island or not, success in the market is achievable only if your head isn’t in the clouds.
