How often do you hear about investing returns?
Mutual funds, investment newsletters (mine included), hedge funds, and even individual investors compare their returns to each other and the market.
Most investors are obsessed with returns.
The truth is it doesn't matter. Not really.
What matters is if you are meeting the financial goals for your own life. The quote below from Robert Allan Schwartz beautifully expresses this:
"I don't have to beat you.
I don't have to beat him.
I don't have to beat an index.
I don't have to beat the market.
I only have to have enough for me."
Say your investing goal is to make a reliable $50,000+ a year in dividend income that grows faster than inflation for your retirement.
What does it matter if your portfolio has capital gains of 8% one year and the market has capital gains of 12%? What does it matter if the next year you beat the market by 6 percentage points?
It doesn't matter if you are hitting your own personal finance goals. Your investments are fulfilling the purpose you set out for them. That is what matters.
Where Does Return Obsession Come From?
Return obsession comes from 2 sources:
- Our innate desire to compare ourselves to others
- The investing industry to justify fees
People rate how they are doing versus against how others do. Said a different way, relative income matters more than absolute income.
The sad reality is many people would prefer to make $50k a year and have all their acquaintances make $40k a year than to make $60k a year personally but have their friends and acquaintances make $70k a year.
Applying this to market returns means we aren't happy with absolute performance. Is 20% return in a year good? Not if your buddy got 30% returns that year, and especially not if the market went up 30% that year.
We compare our performance to the market because that is what we perceive the "average" investor is making every year.
Note: S&P 500 returns aren't even close to what the "average" investor is getting. Over the last decade the average equity mutual fund investor has returns of 4.2% a year versus 7.3% for the S&P 500. If you are underperforming the market by less than 3% a year you are probably doing better than what is really average.
Performance and the Investing Industry
Maids can't charge money and make your house dirtier. Surgeons don't get paid to botch surgeries. NBA players don't make millions because they are so-so at basketball.
It stands to reason that mutual funds, hedge funds, investment newsletters, etc. won't exist for a long if they can't provide 'outperformance' against some benchmark. Otherwise, what's the point?
Performance (or rather, relative outperformance) justifies investment fees.
We idolize those that can generate tremendous outperformance; the Warren Buffetts, Peter Lynchs, and Seth Klarmans of the world.
We also tend to chase investors and funds that have shown "market beating" recent results. Investors chase performance to such a degree that we need the disclaimer: "Past performance is no guarantee of future results" plastered everywhere.
The investing industry stands to gain from focusing on performance in a few ways.
First, focusing on performance can justify higher fees. If a fund has outperformed its benchmark for a few years, it could charge higher fees, meaning more money for the fund owners.
Second, focusing on performance justifies churning portfolios. Performance chasers will trade often, always trying to find the next "hot fund." More portfolio turnover means more money for Wall Street brokerages.
I believe performance tracking of funds is a net win for individual investors. At the least, it can provide a warning against funds with high fees AND perpetually poor performance.
Where the Investment Industry Can Add Value
At the end of the day, we invest for a specific reason (or reasons):
- Retirement income
- Saving for kids' (or grandkids') college
- Saving for a down payment on a house
There are some people who are focused on compounding for compounding's own sake (I don't know him personally, but Warren Buffett appears to be in this camp).
Investing funds, newsletters, and advisors can add value by helping individual investors reach their goals. This can be accomplished through education about how to invest.
Helping to minimize behavioral investing errors will add tremendously to investor returns. Saving individual investors time is also valuable, whether this is accomplished through finding pertinent and compelling investment opportunities (stocks, funds, etc.) or managing their account for them (as investment advisors do).
What's interesting (and scary) about the investing industry is that the amount you charge your clients directly negatively impacts their investing goals. Said another way, the more one charges for investment advice/knowledge/picks, the more they are hurting their clients.
It isn't like this in other industries. What a doctor charges doesn't impact your health (maybe that's a bad example given today's absurd health care costs…); what a mechanic charges doesn't make your car run any better or worse.
The investment industry should focus on helping clients set and reach their financial goals while avoiding behavioral biases and saving them time. The less clients are charged, the better.
Goal Setting Instead of Return Obsession
Instead of obsessing about returns, individual investors should look at reaching their own personal goals.
Learn when you can retire assuming you invest a specific way. Invest for a purpose and stay the course.
By setting goals and focusing on reaching them instead of "Beating the Dow Jones's," you will very likely end up with better overall performance than you would've achieved by over-scrutinizing your performance.
That's because you are less likely to chase performance and churn your account (racking up fees in the process) when you are focused on long-term investment goals.
Dividend Growth Investing & Goals
Many investors' goals require income that grows over time. I believe dividend growth investing is uniquely suited to individual investors looking for growing income over time.
There are many reasons to be a dividend growth investor. First, owning individual stocks for the long run is cheaper than any fund… Because holding individual stocks is free. You can't beat free.
Second, businesses that pay growing dividends have historically performed very well. As this article discusses, focusing on performance isn't advisable, but a long (decades in this case) history of strong performance is a net positive. Seeing decades of poor returns is not a good sign.
Third, dividend growth investing focuses investors on individual businesses and income. Many dividend growth investors look at the income their portfolio generates and how quickly that income is growing.
This is different than looking at performance and what stock prices have done. Looking at income growth instead of price changes helps investors to avoid overreacting to large falls or gains. If a stock falls 20% but its dividend rises 10%, dividend growth investors are unlikely to panic.
An investor looking only at the stock price will likely be far more concerned. In this way, dividend growth investing focuses investors on the underlying business and its results rather than on stock price movements.
In the short run, stock price movements dictate returns. In the long run, the underlying growth of the business dictates returns.
"In the short run, the market is a voting machine but in the long run, it is a weighing machine."
- Benjamin Graham
Focusing on dividend income (in accord with investing goals) helps investors to focus on what matters in investing.
Do returns matter? In a purely mathematical sense, of course they do.
Obsessing over returns is likely to hurt overall performance. Comparing yourself to a random benchmark or other investors can lead to performance chasing. It can lead to focusing on "winning at investing" instead of investing to reach your personal finance goals.
When you choose your investments, know your goals and invest to reach those goals.