If you’re anything like me you started investing because you wanted to make money and the stock market just happens to be the best place to achieve inflation-beating returns over the long term.
Investors must accept, however, that greater returns come with greater risk, along with the possibility that your portfolio might suffer losses of up to 40 percent or more in the short term.
And if you also accept the idea that an investor, even an active one, has very little chance of avoiding such losses then you’d have to wonder if you’re just along for whatever crazy ride Mr. Market has in-store.
Related: Starting your investing journey
Indeed, since none of us has a crystal ball or the ability to forecast, with any accuracy, future market outcomes, the best we can hope for is to set up a diversified portfolio of equities and fixed income, contribute to it often, rebalance whenever it drifts off course, avoid trading on noise from the media, and keep investment costs ultra low.
In a nutshell, we can give ourselves the best chance to succeed by doing all of the above, but at the end of the day we’re still at the mercy of the market and we have to accept what it gives us.
Investors asking the wrong questions
That’s why it’s surprising to hear investors talk about wanting to make money investing in a short period of one-to-two years.
Aman Raina blogs at Sage Investors and two years ago he set up an account at one of Canada’s robo-advisors and invested $5,000 of his own money to see how his portfolio would perform.
I found the question he wanted answered to be a bit strange, however, which was, “do these things make money for investors?”
A robo-advisor is billed as an online investing and portfolio management solution, but in the most basic terms it’s an automated asset allocator.
Related: Nest Wealth robo-advisor review
Robo-advisors offer portfolios of low cost ETFs tailored to your risk profile. Once you choose a model portfolio to follow, any new money added to the account gets automatically invested into the funds according to your desired asset mix and allocation. Robo accounts are rebalanced when portfolios drift 10 percent or so outside that allocation.
There’s no magic involved. Portfolio returns will depend not just on the performance of the underlying ETFs, but on the timing of contributions and any rebalancing that occurred.
Mr. Raina was not happy in year one when his robo-portfolio lost 2.15 percent, but he perked up in year two when the portfolio returned 13.2 percent:
“After the first year, the ROBO had lost 2.15 percent. It had a rough year, but in year 2, ROBO picked up its game. The portfolio generated a 13.2 percent return for the year. Much better job.”
Huh? Did the robo-advisor really do a better job in 2016 than it did in 2015? I’d argue it was the portfolio’s exposure to U.S. stocks and Canadian dividend payers that led to better returns. The robo didn’t do much of anything except stick to the investor’s initial allocation.
Related: A Review of Wealthsimple
What exactly is the robo-advisor’s job supposed to be? In my mind, a robo-advisor’s role is to give investors inexpensive access to market returns via a diversified portfolio of ETFs that get rebalanced automatically whenever appropriate.
I track my portfolio rate of return annually and expect to achieve returns of eight percent per year over the very long term. But even though we’re in the midst of an eight-or-nine year bull market, I full expect my portfolio to lose money in some years. That’s just how the markets are supposed to work.
Asking, “did my portfolio make money” is not an appropriate way to evaluate your investing strategy. The only meaningful way to measure your portfolio returns is against a similar benchmark.
Say your portfolio is down 2 percent in a year. Is that cause for panic? Disappointment? Maybe. But what if you learned that the overall market was down 10 percent? In that case you should be thrilled to only lose 2 percent!
Mr. Raina says, “the key fundamental questions that don’t seem to be asked is whether robo-advisors are more effective in generating positive returns compared to a traditional portfolio management model. Can you make money?”
I think he’s asking the wrong questions.