Most investors don’t have a clue how to properly calculate their returns, nor do they understand the importance of the consistency of their returns.
This becomes especially important when retired, when retirees become dependent on their portfolio to draw some of their retirement income. Before we get into retirement, let’s show you why performance consistency is important.
In the example below, you have two portfolios, both with $1 million to start. Portfolio #1 gets a 10% return for two straight years. The “average” return is 10%, the same as Portfolio #2. Portfolio #2, however, experiences more volatility. Year 1 the portfolio loses 10%, but makes a huge comeback in year 2, with a 30% return.
As you can see from this example, even though both portfolios have the same “average” return, they don’t have the same “average annualized” return or “total” return. The loss experienced in Portfolio #2 impacts the return. The first thing you must understand is the impact of the 10% loss. To get back to breakeven, an investor needs an 11.11% return. In this case, the investor gets 30% growth in their portfolio, which is now at $900,000. The $270,000 growth in the portfolio (30% on a $900,000 portfolio) puts the portfolio at $1,170,000 at the end of the second year. The second investor would have had to have reaped a 34.44% return in year two to catch up to the first investor.
The first portfolio wins because it didn’t have to make up loses experienced in the second portfolio and the first portfolio takes advantage of compounding interest. The first year the portfolio grows 10%, from $1 million to $1,100,000. The second year the portfolio experiences 10% growth again, but this time on $1,100,000. This means the portfolio grows by $110,000, to $1,210,000. This gives the consistent portfolio a 4% advantage after just two years of market performance.
Let’s take it one step further and see how consistency of performance impacts the value of a retiree’s portfolio. We will keep our two investors, the portfolio values, and each of the portfolios’ performance. We are going to assume that our retired investors are going to withdraw $60,000 at the beginning of each year and hope that they can make back that money in the market. As you can see below, consistent performance matters.
As you can see, Portfolio #1 grows to $1,541,872 even with the $60,000 withdrawal every year. The second portfolio, riddled with loses every other year, is barely able to grow, finishing the 10th year with an account balance of $1,152,913.While portfolio performance matters, the consistency is just as important.
This website is solely for informational purposes. Past performance is no guarantee of future returns. Investing involves risk and possible loss of principal capital. No advice may be rendered by Polaris Wealth Advisory Group unless an investment management agreement is in place.
