What Matters Most
If I were to ask you right now, “Do you think your investments are performing successfully?”, what would you say? To determine the answer to this question, I am willing to guess that many of you probably first thought about your current investment returns in your accounts, which quite possibly, might make you feel a bit depressed! But fear not! I have good news for you: Investment return is not the determining factor of whether or not your account is a success. Yes, you read this correctly.
Sometimes (more often during market corrections) we lose sight of what matters most when it comes to our investments. Investment returns are not and should not be the central focus of an investment account. Investments are a means to an end. In other words, they are merely the tools that can help us reach our personal financial goals.
The most important factors that matter in determining the success of your investments are to compare the following:
The purpose of the account.
The account’s average long-term growth pace.
The account’s current balance.
Purpose of the Account
As you review the purpose of your account, these are some helpful questions to ask yourself:
Why did you want to open the account?
What are you planning to use the money for in the future?
How much will you need from the investment account in the future to help you attain the objective of the account?
When is the earliest you will need to pull money from the account?
The answers to the questions above provide you with the target in which to aim your account. It is just like planning a vacation. Before you start the journey, it is
important to know where you are going and why. Then, when you actually do start traveling, the
pace of your vehicle determines when you will arrive at your destination. This leads us to the second important factor.
The Account's Average Long-term Growth Pace
Daily market activity can have some pretty extreme swings from positive to negative returns. Just look at the last several weeks. However, what is far more important is the long-term average return of your account. What has your account averaged over the last 3, 5, and 10 years? The longer
return history you can see, will provide a much more accurate indication of the pace of your account.
Well then, what determines the pace/avererage return of your account? Portfolio allocation. In other words, the weighting of stocks, bonds, and cash equivalent holdings in your account. Cash equivalent holdings have lower investment risk (think of a savings account), so their average gain/loss return potential is pretty low. This is a slow-pace investment vehicle. Stock holdings have higher investment risk, so their average gain/loss potential can be much higher than cash. This is a fast-pace investment vehicle.
Depending on which holding types have the most dominant presence in your account, will determine your account pace/average return potential. So what is the current speed of your account? More
importantly, are you comfortable with this speed? If the recent market activity has affected your portfolio return in a way that has made you feel extremely uncomfortable, chances are your account is going too fast compared to your personal comfort level speed and your should consider changing the holdings in your account.
The Account's Current Balance
This last factor to review is pretty simple. You have to know the current balance of your account in order to know where you are on your journey towards fulfilling the purpose of your account.
Putting It All Together
Comparing all of these elements together makes it much easier to evaluate if your account is performing successfully. If, at your current pace, you:
Will have enough saved in the account to achieve the purpose of your account at the time you need it, your account is performing successfully.
Won't have enough saved in the account to achieve the purpose of your account at the time you need it, your account is not performing successfully.
If you won't have enough saved by the time you need it for your investment goal, it might be time to make a change to either the purpose of the account or the average long-term growth pace. However, it's important to remember that short-term investment return alone is not the sole determining factor of investment success.
by John Witzig