investment returns

This article was first published in the Globe and Mail on May 18, 2024. It is being republished with permission.

by Tom Bradley

Let me guess. When your portfolio returns are positive, your adviser points out the good moves they’ve made. When returns are negative, it’s because of the market.

Do you ever wonder why your portfolio is doing well, or poorly? Is it because of your adviser’s brilliance (or ineptitude), the oil or bank stocks you bought, or what the overall market did?

There are many factors that fuel returns, although the importance of each varies with time. One quarter, it might be those oil and bank stocks doing well, another the telcos dragging everything down. Over time, however, these period-specific reasons, as important as they seem, matter less.

If you, like most investors, have a time frame measured in decades, the explanation of how you did is driven by a consistent list of influences, and the pecking order is pretty much carved in stone.

Here’s what drives your long-term returns in order of importance.

Markets: Your adviser has it half right. The direction and magnitude of your returns are overwhelmingly driven by the overall direction of bond and stock markets, no matter whether you’re indexing your portfolio or pursuing an active strategy. Nothing else comes close.

Stock market returns have three components to them: dividends, earnings growth, and changes in valuation. Dividends are steady (currently in the 2-per-cent to 3-per-cent range) and grow over time. Yearly profit growth is more cyclical but still reasonably stable in the neighbourhood of 4 per cent to 7 per cent a year. The big swing factor, and the one that causes most of the market volatility, is the expansion or contraction of valuations (what investors are willing to pay for a dollar of earnings). In recent months, expanding price-to-earnings multiples have pushed stock prices higher despite little change in the growth outlook. In 2022, it was the opposite.

Asset mix: You can’t control markets, but you can make sure your portfolio fits with your objectives, time frame and personality. Your strategic asset mix, which is the blend of cash, bonds and stocks, is the best tool you have for finding the right balance between reward and risk.

For example, a portfolio fully invested in stocks had annualized returns of 8 per cent to 10 per cent over the past 20 years, with plenty of ups and downs along the way. Over the same period, a five-year GIC ladder generated a predictable return in the low single digits.

Cost: Portfolios with a lower cost, assuming they’re properly diversified, will generate higher returns. There’s no ambiguity about this.

If you’re able to manage investments on your own, you can keep your costs very low these days. If, like many investors, you need help, you’re going to pay more. Professional investment management and counsel costs money to deliver, whether it be simple advice or total delegation.

The key is only paying for what you need.

Security selection: As a former equity analyst and portfolio manager, it pains me to say this, but security selection is down the list of what drives long-term returns. As noted above, there will be periods when it makes a big difference (for example, if you were loaded up with Magnificent Seven stocks over the past few years, or owned none of them), but the good and bad streaks tend to balance out over time.

You: Now the wild card – your own investment behaviour. If you have a plan, are good at sticking to it, and keep your costs down, then the "you" factor is at the bottom of the list of return factors.

Call it neutral to slightly positive.

If you aren’t any of these things, and instead make frequent changes, get in and out of the market, don’t have a plan or know your costs, then you may be the biggest factor in how you do, and it’s most likely negative. I’m generalizing of course, but evidence shows that investor returns are less than those of the funds they invest in because they trade too much, chase past performance, and too often buy high and sell low.

So, the next time you’re reviewing your returns, keep this list in mind. Accept that it’s hard to buck the trend of what the market is doing. Have a plan that aligns your portfolio with the task at hand. Don’t pay for anything you don’t need. And make sure you take a good hard look in the mirror.

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