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Victoria, TX 77901

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Assessing Fair Returns

 As Ben walked through the door, the seventy year old limped a bit and was clutching his latest investment statement.

Ben is a smart, and often blunt man; never one to pull any punches. Rarely does he stop by just to chat. As such, it was pretty easy to know he had something on his mind.

Ben sat down and slid some handwritten notes across the table. He had calculated his portfolios performance to three decimal points. I told him he must be losing his touch since he had not carried the decimal to the fourth place. Ben smirked and quickly got down to business.

He said “The S&P 500 is up 14.06% this year—why am I lagging the market?”

It is a conversation we have had many times before—and a fair one, too. However, to answer this properly any investor must look at their own goals and asset allocation.

Ben is a retired accountant and in typical accountant manner, he is pretty conservative. Understanding this, when he set up his account with us he required that 20% or a full $100,000 be kept in cash. I reminded Ben of this and then pointed out that given where interest rates are—this money will essentially earn nothing. He listened and internalized the figures.

Then we shifted the conversation to Ben’s “tolerance for volatility.”  I told Ben that although I enjoy the discipline of the stock market, it brings with it certain volatility characteristics. Ben leaned back in his chair and asked what I meant.

Most people know that the stock market averages about 10% per year. However, it is a very bumpy ride in getting to that 10% figure.

We always tell our clients that if they are going to be stock market investors they need to focus on the long term—meaning where they want to be in ten or more years—and they need to be prepared for the stock portion of their portfolio to decline by 60% over any two year period.

When I reminded Ben of this he vaguely recalled the conversation. Ben quickly replied that at his age he did not want that kind of volatility.

Given this, we reviewed what Ben did own. About half of his funds were in stocks. Despite being retired, these would give him the best opportunity to outpace taxes and inflation. However, the rest of it was diversified in assets that would give a seventy year old some stability. In doing so, we pointed out to Ben that the more you want in stable assets, generally the lower your overall returns will be.

In simple terms, Ben owned 45% in stocks, 20% in cash, 25% in short term fixed income and the remainder in real estate. We then showed Ben how to identify appropriate indices for each component of his portfolio so that he could see what would be a fair composite benchmark.

Once he ran the math again, a small smile appeared on his face as he said, “Well, I guess that’s nothing to complain about.” I asked if I could get that in writing from him and he dryly said he’d drop it in the mail.

Human nature is such that we always want the returns of the stock market when it is up—but don’t want the volatility that comes with it. As such, we have to know why we own investments. In doing so, every intelligent investor must recognize that different time frames allow better opportunities for success with each asset class.

If you might need to access quick cash—then money market or CD’s are just fine. However, if you are trying to maintain your purchasing power over decades long time frames—then the stock market offers the best opportunities. You just have to stomach the volatility. For most people, a combination of assets offers up the best compromise and opportunities for investing success. 

Dave Sather is a Victoria Certified Financial Planner and owner of Sather Financial Group. His column, Money Matters, publishes every other Wednesday.

Originally published July 2, 2013 at 6:36 p.m., updated July 2, 2013 at 9 p.m. Victoria Advocate