The Good, The Bad and The Ugly
August 2005©
By Neil Sosler & Marc Singer
Expectations are sometimes more important than reality. To understand this concept, lets revisit the last time you were at the car dealer and placed an order for a new “hot” car”. Imagine that the salesman promised you delivery in eight weeks but your car arrives in six weeks.That is good. Now, imagine that the salesman prom-ised you delivery in five weeks but your car arrives in six weeks. That is bad. Finally, imagine that the salesman promised you delivery in two weeks but your car arrives in six weeks. That is ugly. The fixed value in this equation is the actual delivery date: six weeks in each instance. The variable value is your expectation: eight, five, or two weeks. This variable deter-mines if the percep-tion of your salesman's performance was good, bad, or ugly.
The Ugly – Unrealistic Expectations
What about your expectations of stock market returns? Let's start with the ugly. What if you don’t consider the possibility of a 20% or greater drop in stock prices in any year in the near future? You would be ignoring the fact that a 20% drop in stock prices has occurred on average every five years or so since the end of World War II. The last such decline was just three years ago (2002). Based on your expectations, how will you react to the next one-year drop of 20% in stock prices? Will you panic and bail out of the market completely, locking in your losses? Will you sit on the sidelines and miss the next major market advance? Thinking there is no downside risk in equity investing will create unrealistic expectations and set the scene for long-term portfolio underperformance.
The Bad – Never Happy
Moving on to the bad. What if you expect above-market equity returns to continue indefinitely as seen during the 1990s? Many 10-year time periods over the last 100 years show equity returns averaging 14% per year or better. However, the fact is that the annual return of stocks as an asset class has averaged 10.5% over the last 75 years. Based on your expectations, how will you react when stock market returns decline to their long-term historical average? Will you dump your diversified portfolio and chase after higher returns (and more risk)? Will you jump on the sector fund ‘du jour’ bandwagon and incur large losses when that sector falls out of favor (Do hedge funds and real estate come to mind here)? Once again, unreasonable expectations can prove fatal to a long-term balanced financial plan.
The Good – Realistic Expectations and Peace of Mind
And now for the good. What if you have realistic expectations of stock market returns? They are based on long-term historical averages that take the market’s pattern of short-term volatility into account. Realistic expectations help the long-term investor anticipate how a well-diversified portfolio will behave during market cycles. They maximize the discipline needed to stick with a long-term investment plan and minimize the feeling of panic induced by market declines. Realistic expectations can also open an investor’s eyes to buying opportunities created by temporary market declines.
Conclusions
Your long-term financial goals and the plan you deploy to help you attain these goals should be based on realistic expectations. If an “investment opportunity” sounds too good to be true, it usually is. Your financial advisor should not only help you with selecting investments that are appropriate for your portfolio, they should also communicate what to expect over the long-term. With open lines of communication regarding realistic expectations and proper portfolio allocation, you will be on your way to realizing your financial goals.
Singer Xenos is an established wealth management firm specializing in physicians with $500,000-plus in investments. We manage over $500 million in assets such as retirement plans, annuities and personal accounts, with an emphasis on wealth building and protection from malpractice claims. Both Worth Magazine and Medical Economics named Singer Xenos one of the Top Financial Advisors nationally for physicians. Physician Asset Advisor and Singer Xenos do not provide legal advice.
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