The Total Return Fallacy
The financial industry, in my opinion, is big on hyping a portfolio’s total return, which includes both price appreciation and dividends payments, as the end-all metric for monitoring portfolio performance. Rarely I do hear “risk” mentioned in the same sentence. Any portfolio return is meaningless if you don’t understand the risk taken to achieve it in my humble opinion.
The short-term measure of portfolio risk is standard deviation, also known as “volatility”, which tracks the price fluctuations of the underlying securities in the portfolio. Fortunately, more and more performance reporting systems used by advisers are providing “risk-adjusted” total return statistics on your portfolio. The most common measure is the Sharpe Ratio, named after its creator Stanford economist Bill Sharpe. If you are not reviewing your portfolio’s Sharpe Ratio or an equivalent risk-adjusted measure on a regular basis, you should be.
The Unhelpful Benchmark Comparison
To make matters worse in my opinion, many portfolio return benchmarks used for performance comparisons are not risk-adjusted either. So while your portfolio return beat its reported benchmark, that may be of little comfort if your portfolio lost 40% of its value during the great recession of 2008-2009.
The first step is to use “risk-adjusted” returns and benchmarks where possible. Given Koch Capital utilizes four distinct investment objectives—Longevity Coverage, Capital Growth, Steady Income and Cash Reserve, we start with the basic premise of measuring the amount of return per unit of risk taken. If your investment goal is to have your portfolio do well in inflationary periods to help protect against longevity risk in retirement, then it’s helpful to know the portfolio’s real return (nominal minus inflation) adjusted for risk.
Likewise, if your goal is to provide steady, consistent income, then Koch Capital recommends monitoring the risk-adjusted yield of the portfolio. And if your goal is to maintain a safe, liquid cash reserve for emergencies, then the only measure that counts, in my opinion, is “will you permanently lose capital during the next major financial crisis”.
Source: Koch Capital
For more information on our Investment Roadmap approach shown in the diagram above, please watch this educational video which helps investors think about how to focus their investment objectives on meeting future retirement needs.
Think Long-Term Risk
While younger investors may be able to tolerant significant market gyrations, investors nearing retirement don’t have that luxury when planning for portfolio withdrawals to fund retirement. They need to understand the long-term consequences before they act.
When taking regular distributions from your investment accounts, your portfolio becomes more sensitive to short-term market volatility. The short-term market volatility becomes a long-term funding problem if you (1) actually take a withdrawal from your portfolio when it’s significantly down in value—this is known as sequence of return risk—or (2) make a rash, irrational investment decision like selling your entire portfolio at the market bottom.
A solid financial plan will prevent you from making either of these two classic investor mistakes. To learn more about Koch Capital’s approach to protecting your retirement goals from risky investments, please watch this educational video.
Thank you for your consideration.......Jim
About Jim Koch
Jim Koch is the Founder and Principal of Koch Capital Management, an independent Registered Investment Advisor (RIA) in the San Francisco Bay Area. He specializes in providing customized financial solutions to advisors, individuals, families, trusts and business entities so they are better able to achieve their goals. Jim sees himself as an "implementer" of financial innovation, using state-of-the-art technology to provide practical investment management and retirement income planning solutions for clients.
General Disclosures
This information is provided for informational/educational purposes only. The opinions referenced are as of the date of publication and are subject to change due to changes in the market or economic conditions and may not necessarily come to pass. Nothing presented herein is or is intended to constitute investment advice, and no investment decision should be made based on any information provided herein. The information contained herein, while not guaranteed as to the accuracy or completeness, has been obtained from sources we believe to be reliable. Past performance is no guarantee of future results.
Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. Under no circumstances does the information contained within represent a recommendation to buy or sell any particular security or pursue any investment strategy. There is a risk of loss from an investment in securities. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular investor’s financial situation or risk tolerance. Please refer to the Site Disclosure page for additional information.
Nothing contained herein should be interpreted as legal, accounting, or tax advice. Any tax statements contained herein were not intended or written to be used, and cannot be used for the purpose of avoiding U.S. federal, state or local tax penalties. Tax issues can be complicated. Please consult your tax advisor for personal tax questions and concerns.
Use of Calculators, Planning Tools, and Other Devices
The use of any calculator, tool, or similar device contained within or linked to this website is subject to your acknowledgement and understanding that the projections or other information generated by any such tools is not, and should not be construed, in any manner whatsoever, as the receipt of, or a substitute for, personalized individual advice from Koch Capital, or from any other investment professional. The projections or other information generated by such tools regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, are not guarantees of future results, and may not reflect the actual growth or costs of your own investments. These tools are designed for informational and educational purposes only and should not be considered investment advice. No reliance should be placed on any such information when making an investment decision. Koch Capital makes no warranties of any kind, and disclaims liability to any person for any actions taken or omitted in good faith with respect to such tools. Koch Capital obtains the information provided via these tools from third party sources believed to be reliable but not guaranteed. Koch Capital is not responsible for the consequences of any decisions or actions taken as a result of information provided by such tools and does not warrant or guarantee the accuracy or completeness of the information requested or displayed. Please refer to the Site Disclosure page for additional information.
Third Party Information
While Koch Capital has used reasonable efforts to obtain information from reliable sources, we make no representations or warranties as to the accuracy, reliability, timeliness, or completeness of third party information presented herein. Any third party trademarks appearing herein are the property of their respective owners. At certain places on this website, live 'links' to other Internet addresses can be accessed. Koch Capital does not endorse, approve, certify, or control the content of such websites, and does not guarantee or assume responsibility for the accuracy or completeness of information located on such websites. Any links to other sites are not intended as referrals or endorsements, but are merely provided for convenience and informational purposes. Use of any information obtained from such addresses is voluntary, and reliance on it should only be undertaken after an independent review of its accuracy, completeness, efficacy, and timeliness.
