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We are often asked “what can I expect my investments to earn if I work with you?”. While it is an important question, there is no easy answer.
In this week’s podcast, Tom, Brendan, Tim AND Casey weigh in on the best way to set investment performance expectations, the difference between average returns, and returns used in planning calculations.
They also talk about what folks looking for advisors SHOULD be asking instead of inquiring about performance numbers.
Show Notes
Michael Kitces Thread on Asking About Investment Performance
Investing is All About Managing Your Expectations
What Should I Expect My Investments to Earn? – Full Transcript
**Click here for a full downloadable PDF version of this transcript**
Casey Mullooly: Welcome back to the Mullooly Asset podcast. This is episode 406. I’m your host, Casey Mullooly, and we’ve got the whole team here.
Tim: Hey guys, this is Tim.
Tom: This is Tom.
Brendan: And Brendan.
Casey Mullooly: Doing a little roll call around the table there. So we’re going to talk about everyone’s favorite question to answer and that is, what can I expect to earn from my investments?
Tom: Yeah. If we hire you, what can we expect in terms of returns?
Casey Mullooly: It’s a good question that we get from a lot of people, and it’s not easy being on the other side of that discussion because you don’t want to over-promise or under-promise, because it kind of impacts how some prospective clients or people that want to work with you, it affects how they might think of you. So what’s the right way or the best way to go about answering that question?
Tom: I’ll begin by saying that this was the topic of a Michael Kitsis thread on Twitter, and it was pretty eyeopening to not only see his thought process, but also to see some of the responses.
Tim: Yeah, I think it seems like a good question to ask an advisor, but it’s a difficult one to answer. But I think it’s one of those questions that, if you don’t really know a field very well, it sounds like it should be a question that you should be asking, but it might not get you the answers that you are really hoping for.
Brendan: I’ll answer it this way and say that I think that the only useful thing about this question is hearing how the potential advisor answers it. So if they give you an actual answer to this question, meaning like a number or a specific rate of return that you can expect, that’s a great negative indicator that they’re not an honest person and that they’re doing business the wrong way, or they’re just trying to placate you.
I think that you can ask this question and your expectations should be a long-winded answer about the advisor’s philosophy overall, in terms of what to expect with the markets, and their job of answering that question, or actually not answering it, since it’s unknowable and you’re asking them to predict the future, is a great indication of their character as an advisor.
So from that perspective, it’s useful. That’s not how it’s being asked in almost all instances, but I can see how it would have value if you were approaching it that way, which might be shocking for some people to hear, because they might just be directly asking the question, as Tim said, and not realizing that it’s an unanswerable question.
Tim: One of the comments was saying how a more sophisticated investor who does know that it is a really difficult question to answer asks that question, like you’re saying, as a test to the advisor. And Kitsis was like, “Yes, I think that that is the one way that you can actually ask that question. But 9 times out of 10, that’s not how it’s being framed. The person is genuinely asking for, so what? 7% a year? 8% a year? What are we talking here?”
Tom: Yeah, I think as the advisor, you’re just setting yourself up for failure when you get locked into a number like, “Oh, we’re going to make 7% a year.” And the market goes straight down in the opposite direction 20%. How are you ever going to be able to face this client or live up to anything that you say after that? You’ve lost all your credibility by saying that. And so Kitsis goes on to say that he was actually asked this question. And so he started writing this thread really with the idea behind it being, this is not what any consumer should ever ask when they’re trying to vet an advisor. Makes a lot of sense.
Casey Mullooly: Yeah. I think he goes on to talk about how, when advisors do answer that question, it’s usually in relation to what the market is already doing. So if the market, however you want to measure that, returns 10% per year, and an advisor says, “Well, I can do 11.” So they can beat the market by 1%, or on the other side of that equation, “The market’s down 20%, we’re going to be down 19%.” So it’s always, no matter what, the answer is going to be in relation to what the market is doing.
And usually, the way you are different than the market is by taking on more or less risk than the market, which I don’t think people realize that. And obviously there’s a lot of nuance that goes into that because, well, what is the market overall? What’s your benchmark? So then, like you said, as the advisor answering that question, then you get pigeonholed into providing the benchmark that you’re going to beat.
And it just opens up a whole can of worms that I think is… It needs to be talked about, because I think investment performance is one of the reasons why people work with advisors in the first place. But I think the whole point of the thread was that if you’re basing your relationship with advisors strictly on their investment performance, then…
Brendan: You’re going to be disappointed because there’re professional mutual fund managers and hedge funds that can outperform. So the idea that an advisor, even if they’re setting your expectation, that the relationship is going to be, in terms of returns, going to be impacted by what the market overall is doing.
I’m saying that if they’re promising you some rate of return better, then that’s not even a good way to set expectations. That’s awful. You can look at the data out there, and the idea that some financial advisor working with regular individuals is going to outperform the market on a regular basis is absolute nonsense. So again, a good negative indicator.
Tom: Well, what comes along with that is the advisor who says, “Hey, I am going to aim for a very high rate of return because I want to win the business.” You are, to use the phrase that he said, you don’t even know it as a client, you are dialing up the risk. Because that advisor is going to have to really take crazy risks to try and outperform or live up to the number that was mentioned in the first meeting. And it’s just so unrealistic.
Brendan: That’s why you should take this question and reframe the nature of the relationship if you’re doing business the way that we are with folks, meaning that the rate of return, of course, impacts the financial plan and how we get to where the person wants to go. But we’re not predicating the relationship on hitting some kind of a number or a target.
That’s not… We’re not a hedge fund. Then I don’t know that your experience would be better than working with a financial advisor with a hedge fund because their performance isn’t so hot either. But I think the idea being that you have to talk about a rate of return because that’s what gets us where we need to go when we’re talking about plans and goals and stuff like that.
But it’s really just a function, I think as Casey said, of how much risk you’re taking. And the idea being that clients are comfortable with a certain degree of risk and their plan requires a certain amount of risk. And the market, over long periods of time, has offered us such a rate of return.
And so how do we combine all of those factors and accomplished what the person needs to? And that’s completely irrespective of the idea of beating some arbitrary benchmark by 1% or whatever the number is.
The idea is that people don’t know that that’s a bad question, so you have to explain to them why that is and what questions they should be thinking about as they make a decision in terms of who to work with and who not to work with as they’re vetting people.
Tom: I think that’s really well said because I think advisors, at least the ones that we see on social media, they kind of tap dance around this topic. And what they really ought to be doing is educating folks into, what are the right questions to ask an advisor before you get started with them? Instead of just saying, “Well, what can I expect in terms of making money with you or what kind of returns should I get?” We all kind of agree, it’s an impossible question to answer honestly. And it’s a red flag if someone actually answers the question with specifics.
Casey Mullooly: I think the best that you probably could do is point to historical returns which, again, depending on what you want to use as your benchmark and what you want to define as the market is 6, 7, 8%, somewhere in that range. But I mean, we also talk about, all the time, how I think if you provide that answer and say, “We’re going to get 8% per year,” then people are going to expect to get 8% per year. And then in a year like this year, in 2022, when we’re down 10%, they’re going to be like, “What’s going on? You said we were going to get 8 per year. What’s happening?”
Tom: Right.
Brendan: You have to give the context of the historical 8% a year. That’s a great starting point, and then from there you explain how averages work and maybe even talk about the idea of odds over periods of times of just being positive at all. I think those, in terms of day-to-day, it’s 50/50. And then the further you go out, like on a quarterly basis or a yearly basis, it gets closer to three quarters, like 75% and then 5 and 10, you reach 10, 15 years out, you have basically, historically speaking at least, a hundred percent probability of being positive on your investment.
And then you could start to think about, okay, over those longer periods of time, what has the market averaged? But what’s baked into those averages? What’s the spectrum here? If we average 7 or 8% per year, what were the highest and the lowest annual returns during that period?
And those are so broad, and just talking about that from the perspective of, why I can’t give you a more satisfying, direct answer to this question. Because I think people are inclined to distrust an answer that isn’t straightforward, like, “Just give me the answer, I didn’t ask for this storybook.”
But honestly, if somebody doesn’t answer it with a storybook, they’re scam artists. And that’s the difficulty in finding a good financial advisor, is that. It’s because it’s counterintuitive to how we make decisions when we hire other professionals.
Casey Mullooly: Yeah. I think Kitsis had, to wrap up his story, I think it started in like 2004 and he said that, well, a client ended up going with an advisor that said that they could do 8% per year. They wound up investing that client in Lehman Preferred Stock?
Tom: Lehman Brothers Preferred Stock, which…
Casey Mullooly: In 2004, and then we all know what happens. If you don’t, Lehman Brothers isn’t around anymore. And…
Tom: You were preferred stockholder of nothing.
Casey Mullooly: Right. Their investment lost the entirety of its money.
Tom: Which did get a couple of quarters of dividends. So, good on you.
Brendan: Yeah, I think there’s an important nuance too, in explaining historically what the market has returned in terms of maybe setting expectations over longer periods of time. And then again, the context of that and how that’ll vary on a year-to-year basis. But then also when you’re building planning projections, what are you using as the expected rate of return in that plan?
Because often, we’re building plans that are undershooting on what the market has offered historically, as a way to be conservative in our projections, which most people tend to appreciate. I just think that that explanation is needed to share with them why the financial plan might be baking in a grade of return lower than what the market has historically offered, or perhaps what we’ve already discussed in conversations with them.
It’s not a function of us saying that we think we stink and returns are just going to be bad because we’re no good at picking investments. That’s not what that’s about. It’s about being conservative with planning, which is just responsible.
Tom: And now we’ve all seen folks that have come through here to meet with us, that have done their own homework, so to speak, their own math, and said, “Well, I think I can retire because I’m clicking along at about 10% a year.” That’s a dangerous, dangerous approach.
Brendan: Yeah. Markets compounded up like 15% a year for the last decade, but that’s not really… We’re here to provide the context as the advisor to say, “Hey, we probably shouldn’t plan with that moving forward. Although, it would be terrific if that continued, I don’t think you want to plan that optimistically.”
Tim: Yeah. And there are advisors out there who will use those projections in their plans, in their investment returns, like using 10 or 12% a year returns. It’s like Brendan said, you like to undershoot as opposed to overshoot.
But again, I think that that speaks to the difficulty of finding an advisor that really works. And I think Kitces kind of turned his thread into, all right, well, if this isn’t a good question to be asking to help narrow down your search of who you’re going to choose, what are some of the qualifications or questions that you should be asking?
This question that we’ve been talking about doesn’t have a direct answer, but I feel like there are pretty direct answers for the questions or the qualifications points that he laid out in the thread. He started off by saying expertise and education. The bar to become an advisor is unfortunately pretty low.
You can slap financial advisor behind your name if you pass a few tests and that’s pretty much it. So raise that bar a little bit and you start to weed out some of the people who might not be giving you the best answers to those questions that you are asking.
Tom: And he also talked about fee-only versus someone who gets an incentive to sell different investments or different products like insurance or mutual funds or annuities, things like that.
Tim: And a fiduciary too.
Tom: Correct.
Tim: Because sometimes people come in and they ask that question, “How much are we going to make per year?” And if you don’t have a fiduciary duty to be at work in the best interest of the client or tell them the truth, and sometimes not answer their question because you can’t, someone without that fiduciary standard could just make something up just to get the business and close the sale.
We can’t really do that here, and other fiduciaries can’t do that either because it’s against the obligation that we have. We have to be straight shooters with the client. So it’s on us to explain to them everything that we just talked about, about why isn’t a great question.
Tom: Yeah. It also has to be, I think, put in the right context, so to, like speak everything. It’s got to be in the right context. And so, one of the worst answers I’ve ever heard was, to that question, how much should I expect to make with you? Well, last year our clients made X. And that may be the worst answer you could give because you’re, again, setting false expectations of what’s to happen. And managing expectations is probably the hardest part of our job. We have to communicate with our clients and make sure that we’re on the same page all the time with this stuff.
Brendan: Unless the numbers that they’re citing have been audited by some place, like GIPS does them, and there are others. Unless the returns have been audited, there’s no reason to expect that they’re anything other than just a number.
They could just be making them up. So first and foremost that, but then of course, we slap this disclaimer on every piece of financial propaganda you see out there, that past returns are no indication of future returns or some variation of that. Except, we all see it and then go, “Yeah, but what were the past returns?”
Because we, for some reason, think that that’s going to be a useful indication of what is to come, and that’s not a useful indication of what is to come. But I understand, again, the nature of the original question, along with that, I get why people are asking it.
It’s mostly a function of not knowing what is and isn’t a useful answer. So it’s not one that, I’m never going to be, at least initially, upset at somebody for asking, but they have to be receptive to the truthful answer that follows that. Which, as I said before, it’s not… We’re doing a podcast on it that’s now run minutes and minutes.
I mean, it’s not a short answer. I wish I could give you an answer in one line. I know that people prefer, give me the short answer, you’re just talking in circles. But this is something that requires flushing out and further conversation. It’s not a simple answer. I wish it were.
Tom: And I’ll also add that this question usually comes up, if it comes up at all, it comes up in the first meeting. And that’s part of our process here at the firm, what we call the fit meeting. We want to find out if we’re a good match for each other. And so, we encourage people to use that time to ask questions.
And occasionally this question will come up. We always want to make sure that folks who are thinking about working with us, understand our fees, they understand our process, they understand all of these things, but these are topics that really should be brought up. Maybe not posed, maybe this question shouldn’t be posed in exactly that way, but I think it’s important to talk about.
Tim: Yeah. And like Brendan said, you’re not going to look down upon anybody who does ask that question because they don’t necessarily know better. But again, like Brendan said, they need to be receptive to the fact that it is a very long winded answer, we can’t give them that one liner answer to move on to the next question.
And that kind of falls into what Kitsis was saying and communication, I think, is something that you can definitely gel with an advisor on and make sure that your method of communication lines up with how they communicate with their clients.
Because ultimately, if someone’s not receptive to the answer that we give them to that question, unfortunately, if they look hard enough, they’re going to find a bunch of advisors who will give them the answer they’re looking for. And they’re going to find out the hard way that it wasn’t actually the answer they wanted.
Brendan: Yeah, and wish them the best. We can across people who just, they want the actual answer to that question, they want us to spit out…
Tim: Right. But give me a number.
Brendan: A number to the decimal place. And we’re not going to do that no matter how much they push. And some people don’t like that and so we wish them well and we part as friends and we move on, and help the people that we can help.
Casey Mullooly: Yeah. I think it’s difficult because, like you said, if you were… Let’s say you were to build a financial plan based on, or retirement plan based on using those 12% return numbers, you’re going to be able to make the numbers say what the client probably wants to hear, and that you’re going to be able to retire and that you’re going to be okay.
Which is usually one of the other questions that we get in those initial meetings is like, “Hey, I’m thinking about retiring, I need help figuring out if I can actually do that.”
Brendan: Yeah. I guess that part of it just boils down to having a conscience as an advisor, because I’m intending to do this for another 30 years of my life and I’m going to be there when the bill comes due when that person is pissed that their retirement didn’t go the way that we originally laid out for them in the plan, if they followed all of our other advice.
So the idea that I could bake in assumptions that I think are ridiculous, I don’t see what the incentive is. But if you’re just trying to sell somebody something, get in, get out and you’re not going to be there when the bill comes due or you don’t care about that, then more power to you.
Casey Mullooly: I think the incentive for the advisor is they’re going to get the business.
Brendan: Right.
Casey Mullooly: Yeah.
Tom: Right.
Casey Mullooly: In the short term.
Tim: I think it goes back to what I was saying about being a fiduciary and actually caring about the client.
Casey Mullooly: Yeah.
Tim: Because if the sale is contingent upon their retirement plan working, then yeah, everybody can retire and everybody will give you their business if you [inaudible 00:21:33] massage the numbers enough, until you…
Tom: Say the right number.
Tim: Right. Until you underperform that 13% a year that you promised them earlier, and then they’re going to be like, “What happened?”
Brendan: It’s being shortsighted. So if other advisors out there would like to be shortsighted, then they can enjoy the short term business that their going to get, that’s not what we do here.
Casey Mullooly: So I guess it’s more about not… I’m trying to think from the client side of it. Like you said, the certifications, the communications style.
Tim: I think-
Casey Mullooly: What are some other things that clients, if they’re not asking these specific questions, then what are the things that they should be looking out for?
Tim: I think just in general, they should be aware of the fact that what they think might be good questions or what they want to know, might not actually be what they need to hear. Because ultimately, they’re coming to someone for help because they don’t know what they’re doing.
So I’m not going to bring my car to a mechanic if I know how to fix it. Ultimately, I don’t know anything about cars, so I’m going to bring it to someone for help. People don’t necessarily know how to manage their money, so remain open minded and not be hardheaded if an advisor tells you, “Well, that might not be the thing that we want to focus on,” or, “Here’s how we do it. It’s a little different than what you were intending.”
Tom: So this year in 2022, we’re seeing lots of examples where people are making mistakes with their investments, that are probably going to come back to haunt them over the next couple of years.
I’ve lost count of the number of videos and podcasts, where we have talked about what some of these investments, whether it be ETFs or mutual funds, what these returns have been like through good years, bad years, whatever. And then they compare it, Morningstar compares it to, what does the average investor actually get from these returns?
And the difference is wide. There’s a canyon between what investors get and what the funds actually return because the investors are trying to be smart, or their advisors are trying to be smart and move money in and out of different investments, and that usually backfires. It may not appear to backfire initially because you’re scared of the market or the market just continues to go down for months.
Over the long term, you’re not going to be able to time it each time in and out, and then back in to these investments, and so your returns are going to suffer. So the second thing that I wanted to just tack onto what Tim said is by nature, we’re very optimistic people. We’re very optimistic about the future and what it holds for our clients.
But even though we’re optimistic, we have to plan pessimistically. We have to plan for one of the worst case scenarios and see if we can survive with that. And if we can, we’re good.
Brendan: Yeah. I think, like I said before, there’s the difference between what you bake into a financial plan and what you position clients to obtain in terms of returns. Because we started off, there’s a vein of this conversation that would include talking about returns being based on what the market does on a year-to-year basis, which varies, and then a function of how much risk you’re taking relative to the market, that’s what you should expect moving forward.
So it’s like, at a super high level, if somebody is only willing to be in a 50/50 portfolio, then roughly they should expect half of what the market does over the longer term. And then you can talk about historical context, things of that nature. But that’s different than what we bake into a financial plan to be conservative and reasonable.
So those are two separate things. And I think people need to understand that they’re different and why they’re different and what function both of them serve in terms of expectations and where they fit into the plan overall. They’re both important. It’s a little complex and I wish it were easier to give people a straight answer.
I love giving the straight, succinct answer when that’s possible, but in a lot of cases when it comes to finance, whether we’re talking about market returns, taxes, you name it. There’s a lot of things that, it depends, is the answer. And then it’s our job to explain why it depends in a way that is then satisfactory to the person on the other end of it that makes sense, that they can get onboard with.
Tim: I think to circle back to the initial question that you asked me, if people shouldn’t be asking about these specific returns, the things that they could be asking about are similar to what Kitces put in his thread. What are your certifications? Qualifications? Experience in the industry? Are you a fiduciary? How do you get paid? How do you communicate with your clients? What is it like working with you?
Casey Mullooly: How often am I going to hear from you?
Tim: Right. And yeah, what is working with you going to be like? What can I expect from that? And they should be able to give you very firm answers on that, at the very least. And if they don’t have very firm answers on that, then that’s a red flag.
So kind of the opposite of the return conversation that we were just having. There are certain questions in a interview meeting when you’re looking for an advisor that they shouldn’t waiver on, they should have very firm answers on.
Brendan: Fees, investment philosophy, planning process. These are all the things that we touch on in our initial meeting. Yeah, those have clear cut answers. Those are completely within our control. I think that’s the separating factor in the conversation is, things that are within our control, like communication, the other things that I just rattled off, yeah, we have total control over those.
And we do control those, and we have a process for those that we stick to, so the answer’s very easy. But the things that are outside of our control, those are important factors too, they matter, of course. As Casey said, it matters what the investments do over time. So instead of talking about what kind of returns can we expect, maybe talking about the investment philosophy overall, how do you guys invest? How do you approach that?
That’s probably a more thoughtful way to discuss the investments in an initial interview process, to hear what somebody’s doing and whether it sounds like something that is a match for you or not.
Casey Mullooly: Yeah. I think we could probably sit here all day and continue talking about this, but I think to put a bow on it though, the best question that a potential client could ask an advisor is, are you a Mets or a Yankees fan? Just kidding.
Brendan: There’s only one right answer to that question.
Casey Mullooly: We’ve got the Subway Series here tonight. We’re recording this in late August here, so let’s go Mets. Hopefully we can get a split in a series tonight.
If you have questions about how we work, or if you work with another advisor and want to know how we do things, please get in touch with us. We’d be more than happy to give you our succinct, long winded answers. That’s going to wrap it up for episode 406 of the podcast. Thanks, as always, for listening, we’ll be back with you next week.
Speaker 5: Tom Mullooly is an investment advisor representative with Mullooly Asset Management. All opinions expressed by Tom and his podcast guests are solely their own opinions and do not necessarily reflect the opinions of Mullooly Asset Management. This podcast is for informational purposes only, and should not be relied upon as a basis for investment decisions. Clients of Mullooly Asset Management may maintain positions and securities discussed in this podcast.