performance Archives | White Investments

Is your money doing a good job for you?

How do you tell?

What do you use to measure the progress you are making in your financial life?
The three-part framework that I use to support you in making the most of your finances, provides some good perspective: ORDER, PURPOSE, PROGRESS.

Investment Strategy Management (PROGRESS):

If you want to measure how well your fund manager is doing the job you employed her to do, you look at a benchmark.

For example, if you asked her to manage a portfolio of global shares, you can go check the factsheet of the MSCI World Index ETF. This is an Exchange Traded Fund (ETF) that tracks the worlds developed stock markets.

It will give you an idea of how she is doing on a comparative basis.

So far so good. But there are a couple of issues that you note will soon crop up.

1. Most portfolios are multi-asset in nature.

This means they invest in equities, bonds, cash, property and probably some kind of alternative (gold, crypto, Private Equity). Then you have offshore versus local assets, which introduces currency risk.

It becomes less easy to pick a benchmark that captures performance that is comparatively measurable.

One solution is to look at a ‘peer-group’. This is made up of a bunch of funds which have a broadly similar investment opportunity set.

The peer-group will let you know how the fund you own performed relative to other options you could have chosen at the same time.

Kind of like an opportunity cost consideration.

2. Cashflows change things.

A factsheet showing the fund performance conveniently ignores cashflows.

In reality you probably invest money on an ongoing basis, rather than as a single lumpsum.

The impact on performance is significant.

Example: You invest $1 a month for a year. Only 1$ out of the $12 is invested for 12 months. The last $1 was actually only invested for 1 month. If markets were going up over the year, your own performance is going to be lower than the fund factsheet. (Each month you paid more for your investment than at the start of the year). If markets were going down, you bought each month at a lower price and your performance should look better.

Your investment statement, from your platform or admin provider, should reflect your performance including the impact of when you invest or take out money from your account. We call these your cashflows.

In this context, it makes sense to look at your statement and measure it relative to what your planning process revealed as a required return target.

Financial Planning Perspective (PURPOSE):

Any goal you have will have a future target value, a time horizon and an amount you can contribute towards it.

From this you can calculate a required RETURN TARGET that will get you to your goal.

In theory, you would then build a portfolio of investments to target that return requirement with as little chance of failure as possible.

Something like, I need 12% after fees to turn my current R100 into the R1000 I need in 20 years time. How am I doing?

This works to make it more meaningful to your actual purpose.

But markets tend not to work in straight lines.

A 12% return after fees may actually include periods of gains much bigger than 12% with the occasional negative year thrown in.

It can be difficult to know where you are at any single point in time.

As we all know market returns are not in our control.

It could therefore be helpful to measure something that is more in our control. Like our contributions.

The contributions you are able to make are impacted most by our personal finances.

Personal Finance Perspective (ORDER):

How you manage your personal finances determines your ability to meet your required contribution rate (assumed in the planning process).

At least this involves managing stuff that is more in your control.

How you use debt. What your living expenses are. How much you have available as disposable income.

If you are not putting away the money you thought you could, it is highly unlikely your overall plan, based on those contributions, is on track.

If the planning assumptions are not right then there is a good chance your investment strategy is not appropriate either.

What is the point

The point is your success is dependent on getting all three areas right.

ORDER=>PURPOSE=>PROGRESS=>

Measuring your progress in a way that captures all of these elements makes sense. It is a good idea to look at different metrics that are appropriate for each.

We may like to think managing money is a science but there is a lot more art to it than meets the eye.

#orderpurposeprogress

Cumulative Returns

It is important to understand how investment returns work in order to apply them in a meaningful way in your financial life.

Most of the time when we hear somebody talking about long-term returns, they mean cumulative returns.

You have a starting point which you adjust each year by the total return (price + income) for a number of decades.

Just about every equity index over a 50 year time horizon is going to look pretty impressive on this basis.

Exhibit A: S&P 500 total cumulative returns in the graphic ABOVE. Turning $100 invested into $18,000 over the 50 year period.

Who does not want a piece of that?

Cumulative returns are the main reason people repeat very sagely, ‘It is not about timing the market but time in the market’.

But in the real world many of the goals and objectives we are planning towards do not have the luxury of a 50 year time horizon.

Shorter-term objectives should be seen in context

Maybe you are five years away from retirement. Or your child’s education costs you have been saving for from birth, are kicking in a couple of years from now.

When you stop working you will typically begin consuming your wealth and this too is made up of multiple shorter time periods. You will need to cover cost outflows each year into perpetuity.

In this context it would perhaps be more helpful to to consider the returns we are likely to receive over shorter time periods – Let’s say 5 years. If we look at returns over the last five years but on a continuous basis – we call this rolling 5 year returns. (The dark blue line in the graphic ABOVE). Each data point shows you what your annual returns would have been if you had invested 5 years before hand.

As you will note from the graph, it becomes less obvious that just buying an equity index will actually do the best job for you. There are quite clearly a few five-year-periods where nothing much happens. Then there are those where very large returns are enjoyed and inevitably periods where for five years running you lose money.

Why this matters to your financial plan

In planning we often use the average of the cumulative experience (the red line in the graphic) to provide a ‘decent’ indication of expected returns. But this approach knowingly fails to capture the current valuations (expensive or cheap by price-to-earnings for example) and therefore the future expected returns.

And as the graphic below shows, even in a developed market like the US you can go for extended periods without earning any returns at all from shares. This is the S&P 500 index from 1998 (pre-dot.com to well after the Global Financial Crisis (2013)).

How you can improve your odds of success

– You will probably receive returns way above and below the average. You can receive negative returns over a 5 and 10 year period.
– The biggest determinant of future returns is the price you pay for an asset.
– Periods of above average returns are, more often than not, followed by periods of below average returns.
– Extrapolating the most recent excellent 5 year performance of an asset class is almost always wrong for the next 5 year period.
– Paying attention to your cashflows and the timing of those cashflows is very important to your ultimate success.
– Timing the market may be a fool’s errand, but buying regardless of valuations is similarly futile.
– Not aiming to pick the best performing asset class year in and year out is a sensible strategy.
– Seeking better consistent long-term average returns will work better when targeting specific objectives.
– Returns should always be evaluated in context of the risk you must take to achieve them.

performance

How well is your money doing