Are you wondering if your investments made any money in the last 3 years?

Cassie Laymon and Hillary Sunderland discuss the trouble with focusing on trailing returns and why those 1-, 3-, and 5-year returns don’t tell the whole story.

Listen to learn more or contact your advisor if you’re feeling anxious about meeting your goals, we’re here to help!

(Full transcript below)

 

Transcript

Cassie Laymon:
Hillary, I have been hearing some questions from clients, and so I thought I would come here, come right to the source and ask you a question today and have you elaborate on it for us.

Hillary Sunderland:
Okay.

Cassie:
So it seems like the markets are bouncing back. We’re being a little more encouraged by what we’re seeing, and then we get to the end of the year and fact sheets are published and performance people are looking at one year numbers, three year numbers, 10 year numbers, and they might be having some frustration because the last couple of years were a little challenging. And the truth of the matter is those numbers don’t really always tell the whole story. So I thought that’s what I would like to talk with you about today. When we get frustrated and we look at these numbers that are based on a calendar year, I have heard that we’re going to call it endpoint sensitivity, which just means this piece, this one day in time that we’re going to look at. But tell me how would you define that endpoint sensitivity?

Hillary:
Yeah, that’s a great question, Cassie. So the most common way of looking at returns in the investment industry is by using trailing returns. So trailing returns are really point to point returns going back over a chosen period of time from a chosen endpoint. So that’s why we call it endpoint sensitivity. For example, performance reports commonly show trailing returns over the last one, three or five years based on the last quarter end. And because these are point to point returns, the end date you choose for your analysis matters. So if your investment strategy just posted a really good quarter or year like we had in 2023, that recent performance shines in looking at the trailing returns. And investors tend to anchor in their minds that return figure and believe that that’s what they should also expect receive going forward. However, we know if you move that endpoint just a few weeks or months back or forward, you can get vastly different results and that can lead to disappointment and thinking that you’re not achieving your goals.

And that’s what we’re seeing right now with trailing three year returns through the end of 2023. So many asset classes had sideways or even performance that was down over the last two and a half to three years, which has made trailing three-year returns in particular a lot lower than a lot of people would expect to receive. So for example, if you look at a moderately conservative portfolio, the blended benchmark we use for that over three-year annualized period, that returns 0.61%. So very low compared to what you would expect to receive. However, that return is only relevant to an investor if they happen to invest initially on December 31st, 20, and then liquidated their account on December 31st, 2023. And I can’t think of any of our clients who actually did that.

Cassie:
Right? So it’s just this arbitrary day and it really just depends on the day that you pick. We use a calendar year because that’s kind of a measure of time that we’re used to, but that actual date is not necessarily what we should be paying attention to. It doesn’t tell the whole story,

Hillary:
Right? Yeah, there’s a lot of context that you need to have when looking at those returns, and I think one of the things that’s helpful in terms of thinking of this is think about how you would apply this to any other area of your life. So for example, say you want to lose your weight, lose some weight, so you go on a diet, most people would weigh themselves throughout the year and gauge how they’re doing over time because you know that on any given day, your weight can fluctuate by a few pounds. You typically judge how successful a weight loss program is by how well it’s helping you meeting your health goals over time. But when it comes to investing, a lot of people anchor their investment success on a particular day of the year. So assessing investment success based on three-year trailer returns is like embarking on a plan to lose weight over three years, then weighing in on one single day, and then making a decision to totally shift gears based on what the scale said on one day out of over a thousand.

So simply due to how trailer returns are calculated, you’re always going out with old performance and with the new, every time the calendar moves three months or a year, you will at some point see disappointing results over a shorter term trailing period because they’re not steady over time. But that does not mean that you need to throw your investment strategy out. Investing is a process. Returns can be lumpy over time, not in a straight line. And just remember that when there are big market events like we had during the COVID-19 pandemic and the rising interest rate environment in 2022, moving the calendar by just a few months, you can go from negative annualized return to positive within just a few weeks. And so it’s always important to look at those numbers with some context as to what’s going on.

Cassie:
Sometimes when we see these numbers, people get frustrated and they think I need to do something different. It’s very emotional and they say, I need to do something different. So if every time you see a disappointing return, you decide you’re going to change your strategy or move to something else, tell me about some of the dangers of that.

Hillary:
Yeah, so when clients focus on shorter term trailing, that would be one to three year time periods. It can be very dangerous because it exposes you to one of the most prevalent biases in investing, which is called recency buys. So investors have a very strong tendency to look at what happened most recently and then draw the conclusion that what just happened is going to continue for the foreseeable future. So if you see a very strong year-end number like we had in 2023 for some of our strategies, you may think, oh, well, I should expect that return next year too, when it’s probably not going to happen the same way. Or if you see a low number for a trailing three year period, you may draw the conclusion that your returns aren’t keeping pace with your goals and therefore you need to try something different. Both of these expectations are rooted in recency bias and can lead to strong emotional responses that can derail your financial plans.

So what I like to tell people is this is really when you need to lean on your advisor and work with them. We have financial plans for our clients. What you need to do during these times is really to lean on your financial advisor, make sure that you are still on track in meeting your goals and talk to your advisor about any concerns you have and receive what we call behavioral coaching. So talk to your advisor about your concerns and they will help guide you and keep you in a portfolio that’s proper for your situation. And that can be one of the most valuable things to do during a period of time like this.

Cassie:
Okay, Hillary, so this was very helpful. I have one more question for you. Tell me a little bit about your expectations for the year ahead and what, if anything, we can look forward to?

Hillary:
Oh, great question, Cassie. So I’ll separate this in two parts. So one on the equity side, we just hit an all-time high this week on the s and p 500 and the Dow Jones Industrial average, but we’re still seeing pockets of opportunity. A lot of the rally in the stock market over the last few months was concentrated in just a few companies, and we do expect that to broaden out. We also see a lot of value in markets outside of the us. So even though the markets are at an all time high, that doesn’t mean that there are necessarily bad days ahead. We’re really excited looking near ahead though with the fixed income asset class. So on the fixed income side, starting yields are highly correlated with future returns, and they are still near the highest levels in about 15 years. So what we’re seeing in fixed income right now is it’s offering both attractive income and potential downside cushion.

So if current economic conditions persist, and we still have this slow but steady growth bonds have the ability to earn equity-like returns based on today’s starting yield level, if the economy energy recession bonds will likely outperform stocks because the Federal Reserve will need to lower interest rates. And so even though we’ve had some very muted returns, especially in fixed income over the last few years, remember we’re not going to look at what happened in the past. We’re looking to what’s likely going to happen in the future, and we think that there are much brighter days ahead, particularly in that asset class.

Cassie:
Great. Well, thanks for sharing that with us. Thanks for always being willing to jump in and give us a little bit of insight in what’s happening in the markets.

Hillary:
All right. Thanks, Cassie. Anytime.