I love it when someone asks an adviser, “So tell me, how have you done?” Typically, this question is asked to better understand an adviser’s returns from a product or solution in comparison to the individual’s desired returns. They ask this question based on either historical data or their own experiences, including their risk tolerances, investment objectives and even media exposure.
On the other hand, a required return is a return estimate resulting from an individualized and dynamic planning process. It takes into account each client’s unique set of circumstances. There is not a composite or one-size-fits-all category. Importantly, a required return is typically inflation adjusted, since spending and savings patterns are always influenced by prices moving higher.
For example, a balanced portfolio of 60 percent stocks and 40 percent bonds over the past 50 years has had a nominal return of 9.51 percent. However the real, or inflation adjusted, return was only 5.10 percent.
I fully understand the line of questioning and generally lay the blame at the feet of my industry for frequently thumping our chests saying “Hey, look how good we are!” Luckily wealth management is changing, and the focus is more on planning and required returns – not product returns.
Nevertheless, this focus on desired returns vs required returns remains problematic. One expecting a desired return of 9 percent to 10 percent from the U.S stock over the next 10 years might prove to be too optimistic. Additionally, one expecting bonds to return 7.45 percent over the next 10 years (their return over the past 50 years) might have trouble assembling a diversified portfolio when the 10-year Treasury is only yielding 1.46 percent.