Keep your investment performance in perspective

Now that you may be entering your peak earning years, you might be in a position to put more money away for your longer-term goals, such as a comfortable retirement. But when the financial markets are volatile, as has been the case for much of 2022, you could be feeling somewhat stressed when looking at your investment account statements. How should you respond?

For starters, keep your portfolio’s performance in perspective by following these three “Rs”:

Your return expectations should be relevant. Everyone has different financial goals. You might want to retire at age 60 and spend your time traveling around the country. But your neighbor may want to work until 70 and then stay close to home, pursuing hobbies. So, your investment portfolio might look quite a bit different from your neighbor’s, as each of you will require a different rate of return to achieve your respective goals. And it’s this desired return, rather than that of a market index such as the S&P 500, that’s relevant to your goals and that should drive your investment choices.

Your return expectations should be realistic. Generally, your portfolio’s return will depend on three key factors:

1. Market environment – We know it’s virtually impossible for anyone to accurately predict market performance in any given year. Of course, we can look back at what the markets have done over time and calculate an average return – but it’s pretty rare when the market has an “average” year. Consider this: The S&P 500 has seen an average annual return of about 10% since 1926, but there have only been six times when its annual return has been between 8% and 12%.¹ In other words, for nearly a century, the financial markets, as measured by this index, have either outperformed or underperformed the average return in almost every year. So, although a year like 2022 may appear unusually turbulent, it’s actually not that unusual in the big picture.

   Market declines, while uncomfortable, are not unusual. In fact, while the average returns are positive, the market has experienced a 10% decline sometime during the year nearly every year on average.  Remember – volatility, while uncomfortable, is normal.

2. Your asset allocation – While the performance of the financial markets will obviously have a big impact on your individual investment returns, you are not at the mercy of forces beyond your control. Your portfolio’s asset allocation – the mix of stocks, bonds, mutual funds and other investments – will also play a key role in your ultimate results. Ideally, your asset allocation should be based on your goals, time horizon and risk tolerance. And these factors are interrelated – so, for example, the higher the return you need to meet your goals, the greater the risk level you’ll need to take on.
3. Your investment holding period – In general, the longer you own your investments, the greater the likelihood your returns will be positive and closer to the long-term average of the financial markets. Furthermore, by holding investments for the long term, you’ll be less likely to make frequent trades, which could erode your returns.

Your return objectives should be reviewed. It’s important to periodically review your investment portfolio. Are your return objectives still reasonable or should they be revised? Keep in mind, though, that you shouldn’t automatically change your portfolio just because you think its performance is not as strong as it should be. Instead, you’ll want to evaluate this performance relative to your long-term goals and to the investment environment as a whole. Keep in mind that when the market goes through a sharp decline, it can even drag down the price of quality investments, such as the stocks of well-run companies with solid fundamentals and good prospects for future growth.

When should you make changes?

While changing your investment portfolio in response to short-term market drops is generally not a good idea, there may be times when portfolio adjustments are needed:

• When your goals change – When you created your portfolio and chose your asset allocation, you did so with certain goals in mind, such as retiring at a certain age. But if you change your mind and decide to retire earlier – or later – than you originally planned, you might need to modify your investment strategy accordingly. For example, if you decide you want to retire earlier than you previously planned, you might need to add more growth elements to your investment mix. That said, taking more risk to retire earlier may not be the right answer if your time horizon is short. You might consider other options, such as your ability to save more or adjust your other goals instead of taking more risk in hopes you can retire earlier. These decisions are rarely binary – you will likely need to weigh other factors before changing your investment mix.
   
• When the nature of your investments change – It’s always possible that your investments may undergo some changes that may reduce their value to you. For instance, you could own stock in a company whose products or services are no longer as desirable as they once were, or the company could belong to an industry in decline. If things like this happen, you could be better off selling the investment and using the proceeds to purchase other ones that can help you. Again, though, such a move should be based on an investment’s long-term prospects, not its short-term performance.
   
• When you need to further diversify your holdings or rebalance – Diversification is a core principle of investment success. By holding a variety of investments in your portfolio, you can reduce the danger of taking a big hit if a downturn primarily affects just one asset class. (Keep in mind that diversification can’t prevent all declines.) And yet, your portfolio could become less diversified over time without you having taken any actions at all. This can occur, in one scenario, if the value of your growth stocks increases so much that this segment now takes up more space in your portfolio – and with more risk – than you originally intended. When this happens, you may need to adjust your holdings (called rebalancing) to bring your portfolio back to the balance you intended.

Think long term … but check your progress

As an investor, time is on your side if you have many years until retirement. As long as you don’t need to tap into your investments to meet your living expenses, you can afford to overlook the inevitable downturns in the market, though they may seem disruptive at the time. And once you reach retirement, since growth will likely still be important, you’ll work with your financial advisor to create a strategy to weather these normal ups and downs while helping to ensure you have the retirement income you need. 

No matter what’s happening in the markets, it’s important to work with your financial advisor to make sure you’re on track toward your goals.

¹Morningstar Direct.