What have your investment returns been?

We are often asked during the interview process, "What have your investment returns been?"

Embedded in this question is the belief that higher returns are better.  At face value, this is both a logical question and a belief. This is especially true if you believe the primary role of the advisor you are hiring is to generate the highest returns.  

However, it's not the highest returns you want. It's the ability to pay for what's important with the highest degree of certainty.  

What Investments & a Pitcher’s Velocity Have In Common

Focusing on investment returns is equivalent to focusing on velocity for a pitcher. Both are important; however, neither guarantees success.

Young baseball pitchers focus almost exclusively on maximizing velocity because MLB teams draft players and promote players to the big leagues based on it.

However, ask any MLB veteran, and they will tell you maximum velocity alone doesn't guarantee a successful MLB career. You have to be able to throw strikes, change speeds, and stay healthy.

Venture Capital Is Max Velocity

Do you want the best investment returns? If so, you would only invest in illiquid early-stage private venture capital.

According to a study by Cambridge Associates, the average rate of return for venture capital is 21.9%. Almost double the public stock market, which returned 12.2% over the same period.

However, venture capital is also considered the riskiest type of investment for two main reasons.

1. Illiquid - If you have a successful outcome, your money will still not be accessible for eight to twelve years.

1. High failure rate: On average, eight of ten early-stage venture companies will fail.

So, if you need access to your money in the next seven years or want high confidence you won't lose it, you have no choice but to accept lower returns.

Furthermore, to have access to the top early-stage private venture capital opportunities, investors must be what is called a “Qualified Purchaser.”  

Qualified Purchaser Definition: “An individual or married couple is a qualified purchaser if they have $5 million or more in investments or joint investments, excluding their primary residence or business property.” Source: Securities and Exchange Commission: Qualified Purchaser Definition  

Your Investment Portfolio Is A LineUp

Using another baseball analogy, a MLB lineup is constructed to maximize the probability of scoring runs to win the game, which is a different objective than maximizing the probability of hitting or preventing home runs. In 2023, Kyle Schwaber hit 47 home runs yet struck out 215 times with a .197 avg. There were also 74 games in which Schwaber did not get a hit. Said differently, a lineup of only Kyle Schwabers does not guarantee a MLB club will make the playoffs.  

A GM is trying to generate wins and will assemble a lineup of nine players with different strengths (diversified) who collectively give them the best chance.

This is the same approach a financial professional takes when constructing an investment portfolio.

What Are You Hiring An Advisor To Do?

Are you trying only to hit home runs or win the game? When working with an advisor, your metric for evaluating their success will determine how they provide their service. If you want the highest returns, they will fill your portfolio with risky investments to reach for returns, which may create disastrous results.

If you hire a financial team to help you make the wisest choices on all your money decisions, your portfolio will look much more like the diversified lineup. Why?

A New Definition of Winning (Success)

Before choosing what to invest in, ask yourself, ‘Why you are investing?’

• What will you use your investment returns to pay for?

• What are the priorities you want to achieve?

• When do you need access to the money?

• How much certainty or confidence do you need that the money you invest will be returned or will increase?

Answering these questions will clarify your definition of winning the success game.

True success is using your money to pay for what is most important to you and impact the people you care about most.  

Once you know your game and how to win, you can build the right team (investments), which gives you the best opportunity to achieve your priorities with the least risk possible.

Your investment returns will be a result of your unique portfolio. A combination of investments that most likely no other individual has because no one else will have the same priorities as you.

You can see the fatal flaw in comparing your total investment returns to someone else.  

Investment Returns Do Still Matter

With all that said, you should evaluate each asset class's investment returns (category of investments) against the standard benchmark.

Returning to baseball, you want all-stars at all nine positions in your lineup—players who out-performed their peer group.

Once you determine your priorities and appropriate risk metrics, your investments should be evaluated against their benchmarks.

As an example,  

• If you are investing in large companies in the United States, your investments should be measured against the S&P 500.
• If investing in developed international companies, your investments should be measured against the MSCI World Index.
• If you invest in bonds (fixed income) in the United States, your investment returns should be measured against the US Aggregate Bond Index.

The Only Returns You Care About After-Tax & Expenses

Another pothole to avoid is comparing before-tax investment returns. The investment companies are documenting what recoveries they can provide you before you have to pay taxes.

Unfortunately, as you are aware, only some pay the same amount of tax. Two individuals could own the same investment yet have different amounts of money in their pockets.  

If you are in the highest tax bracket, your investment income will be taxed between 37 - 50%, depending on your state, and your capital gains rate will be 23.8%.

What leads to the highest expected after-tax returns?

Research done by Vanguard has shown that beyond picking individual investments, the following tax planning strategies can add ~ 2.57% annualized return.

• Asset Location .75%

• Rebalancing .35%

• Tax-loss Harvesting .77%

• Tax-Efficient Withdrawal .7%

Research also shows that expenses and fees quickly destroy your investment returns.

Comparing gross returns are irrelevant for you as an individual investor. You want to maximize the money in your pocket after taxes and fees.

Resources To Listen To

• How to Evaluate your Portfolio's Performance | AWM Insights #161

• 1,982% Return: Are You Willing to Do What It Takes? | AWM Insights #132

• The Portfolio for Multi-Generational Wealth | AWM Insights #85

• Do You Know What Returns You Should Expect? | AWM Insights #61