When we shop for a bottle of wine on our own we invariably look to price and shelf location for guidance. Similarly when judging mutual funds for our 401K’s on our own, our only guides are return and how they are presented by the fund providers. Return serves as a shortcut grading system of how the fund has fared over the market’s recent past.
Problem is, the future might easily vary enough from the past to drop your fund’s return well below what you expected or hoped for. With our bottle of wine, price and shelf placement are determined by factors other than goodness, and future returns may look nothing like past returns. You might easily find that you prefer your $20 splurge wine over that ‘special occasion’ $50.00 bottle.
Actually return is just a number – a historical number. It is highly variable and can easily change rather significantly when dates are shifted by as little as a day. In fact, much of the stock market’s return and losses are realized in very short periods of time, with little notice.
When people think of returns they are generally focused on the stock market. Will the DOW reach X thousand this year? What’s your view on stocks now; should we buy or sell? Should we have some gold or real estate? How can I reach my goal of X million faster?
The better questions to ask are:
- How much can I stand to lose without losing confidence in the stock market and leaving the only engine that can propel most investors to their goals?
- What is the best way to capture the returns of the capital markets (stock and bond) without over-exposing myself to the risks of big market swings occurring at times when I need my money or when I add large chunks?
- How much do I pay in expenses, fees, and taxes to capture market returns? These leaks in my wealth must be replaced by additional savings or risk-taking.
- How can I be guaranteed of getting market returns without risking under-performing the markets?
- Finally: Am I really interested in greater returns or in greater wealth? After all, it is wealth I will spend, not return, right?
When you pay too much for a bottle of wine you didn’t enjoy, it’s not the end of the world. You promise yourself you will avoid the price trap next time; maybe you even resolve to get some advice.
But the bigger question is how will you think about return the next time you become deeply disappointed by your hot shot mangers? Remember, big returns on your money are not necessary if you don’t lose it in the first place.