Guaranteed Market Return

If you choose to invest in equities, you also need to select a strategy to guide you on that journey. Once you start to implement that strategy, you will do so in one or more markets around the globe.

This implementation mix will define a benchmark total market return for your portfolio. For example, if you decide to hold 60% in the UK and 40% in the US, then the benchmark return can be calculated as a blend of the different market indexes for those funds (with dividends reinvested). This benchmark return has to take account of transaction fees, since it is impossible to trade in a market without incurring fees. Even seemingly “fee free” apps have features that reduce your returns so that the broker can make the money they need.

This benchmark has no opinion. It is a neutral, mathematical calculation which does not need to be debated. However, it is fundamental to judging the progress of your actual investment approach.

There are three possible outcomes over any time period you choose:

  • Your portfolio can underperform market return
  • It can equal market return
  • Your returns can be greater than market return.

No-one intentionally sets out to underperform the market (although many end up doing so).

Index funds, by design, equal market return. In fact, they guarantee market return over every time period. If you are happy to receive market return over the next 20, 30 or more years, then you need look no further than index funds. They will meet your goals.

If you are not happy about only receiving market return, then you have no choice but to pursue an active strategy. The risk you pay for this is that you might end up under performing.

It’s often assumed that active investing has a 50:50 chance of beating the market, and you might fancy your chances on a coin flip. However plenty of academic studies have found that historically, around 80% of professional active funds underperform the market.

The primary reason is that underperforming funds get shut down and over performing funds attract so much new money that they are unable to scale up to deploy that money under the same strategy. Either way, it’s tough for professionals to beat the market.

A lot of inexperienced investors prefer active investing. They believe you have to outsmart to succeed and they are willing to put some money behind that approach.

As it happens, investment return is only the fourth most important factor when it comes to wealth accumulation. If you are new to investing, I believe it’s better to focus on the other three things and accept guaranteed market return from index funds.

Read more on this topic . . .


Disclaimer

I am not your financial adviser.

The information in this post relates to my financial journey. It may or may not be relevant to your own. You need to make your own decisions on your own financial strategy.

Do not buy or sell anything based solely on what you read.