Why Your Rate of Return Matters (and what to do – and not do – with it)
I sent my kids to school on the day after Labour Day with a feeling that it hadn’t been a great summer. We hadn’t gone swimming or canoeing enough. I worked too much. Woe, etc.
This isn’t a new feeling. Friends will testify that I become a mopey sad-sack in the last week of every August because summer is over and I wasted it, ergo I’m a terrible person…
If it truly hasn’t been a bad summer (and it never, ever has been), friends with little patience for Emo Sandi snap me out of my not-quite-end-of-summer funk by enumerating all of the things this particular summer held:
Swam with the kids every evening the weather let us? Check. Bought an old beater canoe and paddled happily around Gull Lake almost every weekend? Check. Slept with the windows open? Hung the bedsheets on the line to dry? Worked on the front porch nearly every day? Check, check, check.
I’ve frequently heard similar angsting expressed by people despairing over their investment returns: it feels like I have the same amount of money I started with, I should switch advisors, investing is a scam….The stakes are higher, but these people are making the same mistake that I do every September: letting feelings rule the roost without making the effort to substantiate those feelings with fact.
If you’ve ever said any variation of one of the phrases above, you might be right. Maybe your investments really are flaming hot garbage. But maybe – just maybe – you don’t have all the facts, and even if you can check all of the other boxes you couldn’t say for certain what your portfolio has done for you lately.
Coherent investment policy? Check. Disciplined execution? Reasonable cost? Check. Rate of return?
Rate of return?
While ignoring your investments is probably better than monkeying around with them every day, especially if you’ve ticked all those other boxes above, staying up to date on the amount of money they gain or lose over time (otherwise known as your rate of return) is necessary, and an important item to check off your regular money maintenance list.
Why is your rate of return so important? Glad you asked:
Your rate of return can tell you where your bad feelings about investing are coming from
Your feelings about your investments might not come from the investments themselves. You might be paying too much attention to people with a vested interest in making you feel uneasy and out of your comfort zone: think people who earn money every time you switch between funds, hop into and out of the market, or pay a premium to buy investments that have some kind of insurance built into them, whether that’s appropriate for you or not. Knowing what you’re actually earning is a good antidote to the insidious worry that this kind of parasite feeds on.
If you know that you need to earn 4% per year on average to fund your retirement because you worked it out as part of your financial plan (whether you did it yourself or involved a professional), and you’ve been earning 4%, that’s good news.
If your rate of return is 4%, and you know that other investors, with the same asset allocation, virtually identical holdings, and similar investment policies are earning 7%, and you never made a conscious choice to sacrifice some of your returns in exchange for management or advice of some kind…that’s not such good news.
It’s very, very unlikely that you’ll earn 4% year in and year out (impossible, in fact), and while what stocks did from January 1 to December 31, 2016 won’t tell you a whole lot about how much you’ll be able to spend in retirement, it’s a useful way to compare your returns to what they should be, but there’s more to it than that.
The compound rate of return for your portfolio matters; the rate of return for your account does not.
If you’ve been fortunate enough to have money to invest for the future, you could pull out your statements right now and look at the rate of return for each account, or log into your dashboard and it will tell you how much your account(s) have grown (or not) over almost any time period you care to name.
Of course, if you have money stashed away in a TFSA, an RRSP, an old pension that you transferred to a LIRA, and your Group RRSP, and especially if you have a partner with the same laundry list of accounts, the rate of return for each account will only matter when you combine it with all the other money you’ve earmarked for the same goal, irrespective of what account those savings are held in.
Calculating your portfolio rate of return
If you want to answer the question “Is my portfolio right for me or should I change something about it?” using all the facts at your disposal, and you don’t know your rate of return, you can do one of two things: ask your advisor or calculate it yourself.
Asking your advisor can be a pretty great litmus test for whether you have a good one or not; most institutions only calculate your rate of return for individual accounts, so if your advisor A) recognizes the importance of portfolio-level reporting, and B) is either willing to do it for you or already does it as a matter of course, chances are you’ve got an advisor you should keep.
If, on the other hand, your advisor doesn’t return your calls, is cagey about portfolio-level returns or returns in general, or if you’re managing your own portfolio, you’ll need to do the work yourself. You’ll need your monthly statements, and one of the following tools:
- Justin Bender’s Rate of Return Calculator (you’ll have to hack it a little by adding up balances to get a portfolio-level calculation, and stringing together calendar year returns to get more than just a single year’s return)
- Morningstar’s portfolio feature (you’ll have to sign up for an account to have access to this), or
- Four Eyes Financial’s soon to be released portfolio tracking tool.
Snap Out of Your Investment Funk
If I start making plans for Summer 2018 based my feelings (or, more accurately, my fEeLiNgS) about Summer 2017, I’m going to exhaust myself and my children chasing an imaginary summer.
If you start buying different stocks or switching advisors based on your fEeLiNgS instead of all the available facts (including your investment policy and its execution, cost to invest, and rate of return), you’re not only going to exhaust yourself chasing an imaginary portfolio, you’ll be burning money while you do it.