Institutional Thinking for Individual Investors™
By Mitch Zides, CFA, CFP®, AIF®, NSSA® November 21, 2014
Over the course of my investment career, I have been fortunate enough to work alongside many of the smartest investors in the world. A few of these managers posted annual 20%+ returns over their entire careers and managed upwards of $30 billion. Intellectually, the best investors shared similar investment approaches and took long-term views. Textbooks have been written on unlocking the secrets of how these investors beat the market year-over-year.
The importance of keeping score
In this article, I would like to share with you important insights from the best investors that you can apply that will help make you more money and it has nothing do to with selecting investments. What all the best investors have in common is that they keep score. They all know exactly how their investment results materialized. These investors have set a bar and are trying to beat it on a daily basis. They understand the tremendous power of compounding and how exceeding this bar will make more money over time.
To illustrate the importance of benchmarking and compounding, the chart below shows the annual returns of a $100,000 investment over a 30-year period using incremental returns of 1%.
Source: Constant Guidance Financial – This is a hypothetical example that is demonstrating a mathematical principle. It does not illustrate any investment products and does not show past or future results.
A 4% change in return from 6% to 10% can be the difference between you retiring comfortably or having to scale down your lifestyle in retirement. However, many of us are playing this game without ever looking at the scoreboard. Most investors are typically too busy to calculate these numbers or don’t know how to make sense of these numbers.
Selecting a Proper Benchmark
If you currently work with a broker, they might be calculating these numbers, but from my experience this is not the case. I have evaluated the investment statements from hundreds of these brokers and I have only seen a few who have set a benchmark for the portfolio that they manage. Each year you should receive a report card of your performance to evaluate whether your portfolio has generated the highest possible returns to meet your goals. Brokers tend to focus on relationship building rather than investing because they just don’t know how or don’t have the tools to create a proper allocation1. The advisors that I have seen that excel in creating portfolios tend to come from an investment background and recognize the importance of portfolio management. Others are not educated in asset allocation or do not have the knowledge to properly evaluate a portfolio.
As the chart above showed, each 1% increase of early return can be the difference in over $100,000 over the course of your life. The next step that you should take would be to a select the proper benchmark that will allow you to evaluate what went wrong or how you can improve the risk/return profile of your asset allocation. By no means should you ever fire an advisor who has underperformed the benchmark over a short time period. Markets go in and out of favor and you really need to evaluate someone over a full market cycle. On the other hand, if your broker can’t produce these numbers or can’t thoroughly articulate their investment philosophy you might start thinking about making a change.
Learning from the Best
One of the most popular investment letters that comes out each year is Warren Buffett’s yearly letter to shareholders – http://www.berkshirehathaway.com/letters/letters.html. Each of his letters begins with a table that shows how he increased book-value per share versus the S&P 5002. With this statistic it is easy to see how much value he created during that year. At the other end of the spectrum, is an investor like Jim Cramer who on average recommends 5-10 new investments a night which total hundreds over the course of a year which make it virtually impossible to determine his investment results.
If you work with an advisor, you should ask them to determine your average yearly return and how that performance stacks up against a benchmark. It is also important for them to select the correct benchmark. Similar to your fingerprint, everyone has a different risk profile and attitude towards their money. If your advisor can’t come up with these numbers, I would recommend working with someone who can calculate the risk/return versus a benchmark that is most suitable to you.
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Advisory services offered through Constant Guidance Financial LLC, a registered investment adviser.