Investment Performance

I had a client who phoned me to say he’s moving his account to another brokerage. I  respect his decision, and I asked him what made him decide to move. His answer really didn’t surprise me, because it’s been present in every conversation we’ve had over the last two years. The performance hasn’t been what he had expected. He will be moving to a discount brokerage and buying ETFs. I wished him well, but his phone call made me think.

This particular client has always been unhappy with his returns. The reason seems to be his expectations. The rule of 72 postulates that your money will double every 10 years at a compound growth rate of 7.2%. He was a client for about 12 years, so in his mind his money should have doubled (even at a rate of 6%). He has deposits going into most accounts, so it’s been hard to judge. But he looked at a retirement account that was created with a single deposit and notes that it hasn’t yet doubled. Therefore, he is unhappy.

Are his expectations realistic? Looking at the performance of the S&P TSX over the last 12 years, is up 80% (not having yet doubled) over the same period (5.4% per year). When we say that the market returns on average 8% – 10% per year, what we should actually say is that the market almost never returns 9%. It’s usually much more or much less in a given year. In fact, if we look at rolling 10 year returns (starting with 1985-1995, then 1986-1996, until 2000-2010), they have ranged from as low as 4.5% (per year) to as high as 15.5% (per year) for the 10-year periods (with the average at 9.5%).

This is why professional money managers compare their performance to a benchmark. If you invested in 30% bonds, 70% stock, would you expect returns equal to the TSX? No, since bonds perform differently. Would you compare your globally diversified equity funds to the Canadian market? A client tried to justify that by saying: instead of owning these funds, I could have bought the TSX index fund. Yes, you could have, but that’s judging your asset allocation decision, not the investment prowess of the manager.

The client who is moving to ETFs doesn’t have to worry about choosing a correct benchmark any longer; he’ll own the index. But over what time period should he be judging his performance? We made some mistakes early on, recommending a professional money manager that underperformed. We corrected that mistake, and performance has improved. Over the period 2001-2010, this client’s accounts have beat the market (after fees) by 2% per year. Much of that has come in the last 12 months, where his account beat the index by 16%. Should he base his decision on his experience the past 12 years, or the past 12 months, as some indication of the future? I’m not sure I can answer that.

Although I wish him well in future, here are the problems I predict for him. I suspect that he will never be happy with his performance. No matter how well he does, there will always be someone who has done better. Perhaps that won’t be such a problem, since he’s resigned himself to the performance of the index (less fees). But what if the Canadian index does poorly? Will he switch into the S&P 500 index, or Brazil, or China? Worse, he’s guaranteed to lose, after fees. If the market returns 15.5%, he’ll earn 15%. If the market returns 4.5% over 10 years, he’ll earn 4%. Is that acceptable? It’s a very real possibility.

Market crashes are a time of flux, where investors re-examine their assumptions and their systems. Some will change their strategy, some will change their advisor and some will make the effort to learn to do it themselves. Any of these can be a good decision, as long as it’s rational and not emotional.