Most financial decisions are a battle between the world as it is and the way we want the world to be; between reality and wishful thinking. To avoid letting wishful thinking put you on the wrong financial path, you need three agreements:
First, agree on reality. Facts, truth, and evidence exist in the financial markets. Use these tools, don’t ignore them.
Second, agree on purpose. What is your purpose for investing? Your purpose is the only thing that matters.
Third, agree on measurement. How will you know your investing experience is successful? What will it look like over a specific time?
All That Glitters is Not Gold
In my experience, most investors “run off the rails” on the very first agreement...reality. The hot investments, star money managers, “can’t lose” strategies, and fancy techniques gobble up a lot of mental energy for investors. A quick example might help. A few years ago, we had a discussion with a client who wanted to reallocate a sizeable portion of his portfolio into gold during the 2010-12 period when gold was performing well. He was very surprised when I advised him that despite 2 or 3 years of good performance, the longer-term inflation adjusted performance of gold was (and still is) near the bottom of all asset categories. In fact, the long-term expected real return of gold was (and still is) near zero. We can all have varying opinions, likes and dislikes, but no one can change reality. Evidence exists within the long-term history of the investment markets. Let market history work for you and don’t allow what you wish were true to override this evidence.
Don’t Throw Darts in the Wind
Without understanding and acknowledging reality, the money decisions that follow are like throwing darts in the wind. People want to be smart with their money and make good decisions, but a skewed version of reality creates obstacles. It’s important to make sure that your vision aligns with reality, what actually exists, versus mere wishful thinking.
Sometimes, prospective clients say they don’t have any particular goals except to “beat the market”. Well, newsflash, “beating the market” is a desired outcome not a real goal. What’s the reason for the goal, what’s the purpose?
Our Common Purpose
Everyone has a different personal purpose for investing but there are still some common threads. For those with retirement on the horizon, successfully transitioning from saving to spending is usually near the top of the list. Sustaining their existing lifestyle for an indeterminate period of time in the future is usually among the desired outcomes as well. These are real, concrete goals that a rational investment strategy can be built around. On the other hand, “beating the market” is simply wishful thinking.
How do you measure progress? How do you know if you are on track? As hard as the First Agreement might be, the Third Agreement, how to measure success, is a close runner up in terms of difficulty. The reason we put this agreement last is because you need the understanding of the first two agreements for this to work. You need to recall market evidence and remember your investing purpose. These elements inform your framework for measuring progress.
Why the S&P is a Bad Benchmark
The most common error in looking at the Third Agreement is to apply a common benchmark, like the S&P 500 or even worse, the Dow Jones Industrial Average to your portfolio. The S&P 500 consists of only the largest 500 U.S. stocks and the Dow, a subset of just 30 of these giant U.S. stocks. Unless you have a portfolio that consists solely of large U.S. stocks and no bonds, these aren’t good benchmarks. That is, if you have small stocks or international stocks, these may often perform differently and that’s generally a good attribute over the longer term.
Most likely, (absolutely if you are a client of ours), your portfolio is globally diversified and holds stocks and bonds from other countries. The U.S. stock market comprises just over 50% of the global market. Therefore, if you ignore everything outside the U.S., almost half of the world market is beyond your reach. That’s not smart.
Because the global markets perform differently than ours, there will inevitably be periods where there is a wide deviation between them. 2017 was the most recent example where the S&P 500 Index produced a stellar 21.8% return for the year and the Dimensional Global 60/40 Index returned 14.8% (primarily because of international stock holdings). Years like 2017, as well as, years where the international market excels should be expected. It’s simply part of investing.
Stop Wishful Thinking
If you agree on reality, purpose, and measurement your odds of having a successful investment experience and achieving good long-term outcomes rise significantly. This doesn’t mean that your portfolio will be up every day (remember that the U.S. market is positive only about 54% of the trading days). It also doesn’t necessarily mean you will “beat the market” but instead you will receive the returns commensurate with your level of diversification and risk.
Wishful thinking can be dangerous to your financial health both today and in the future. Don’t fall into that trap. Find the trajectory that aligns with your personal purpose. Start there. Ready for a real conversation?