3 numbers that actually matter for investors
Dive into the numbers that matter over the long term for investors.
In Morgan Housel’s book, Same As Ever, he speaks about permanent and expiring information. This is in line with the theme that focusing on the things that don’t change is more valuable than spending all your time trying to predict an unpredictable future.
This is applicable to investing. There is an obsession with numbers - the short-term results for companies, what the market did overnight, a singular RBA monetary policy change. Analysts and traders are fixated on the impact this noise has on short-term market movements. For a long-term investor, this information is largely irrelevant. Housel considers this as expiring information - inconsequential for anyone a few days after release.
Permanent information consists of things that never change. As Housel puts it, this is knowledge found in books and not in the churn of the news cycle. As investors, there are many foundational concepts that will never change.
Here, we’ve trawled through recent research and data to find insights that 3 numbers that actually matter to investors. In a world where numbers are rarely permanent information, these numbers matter.
78%
78% of the best return days occurred in a bear market.
Changing how much money is invested in the market based on short-term views is called tactical asset allocation. This can severely rig the game against you. Over the last 30 years, if you missed the S&P 500’s 10 best days, your return would be cut in half. If you missed the best 30 days over the last 30 years, your return would be 83% lower. Most of these days occurred when the market felt risky.
This is why timing the market doesn’t work, but also why an overreliance of tactical asset allocation in your investment strategy can also be an issue.
My investment strategy does not involve having large amounts of dry powder sitting there and waiting to jump on a downturn. Not being invested means missing most of those days that contribute to the majority of your return. I don’t want to miss out.
100%
Asset allocation is the most impactful decision you make in your portfolio and 100% of your performance is attributed to it.
Asset allocation contributes more to your return outcome than choosing between two stocks, or between two ETFs. These decisions tend to immobilise investors more than the high-level asset allocation in a portfolio.
There are several studies that show the importance of asset allocation to overall return outcomes.
In 1986, Brinson, Hood, and Beebower’s seminal paper ‘Determinants of Portfolio Performance’ attributed 93.6% of investment performance to asset allocation. The paper focused not on the absolute return level, but on the variation of returns. A 1991 update to the paper concludes that active decisions on investment selection by pension plans (which were used as a basis for the study) made little improvement to performance over a 10-year period. The paper championed a focus on strategic asset allocation over the long-term to increase the chances of reaching successful outcomes.
There were several adaptations of this research by other academics, including Ibbotson and Kaplan’s report in 2000 -‘Does Asset Allocation Explain 40, 90 or 100 Percent of Performance?’. Ibbotson and Kaplan focused on the key question for investors—what percentage of the actual return comes from the asset allocation decisions that they make? Ibbotson explains the results in a CFA Institute paper from 2010:
Asset allocation policy gives us the passive return (beta return), and the remainder of the return is the active return (alpha or excess return). The alpha sums to zero across all portfolios (before costs) because on average, managers do not beat the market. In aggregate, the gross active return is zero. Therefore, on average, the passive asset allocation policy determines 100 percent of the return before costs and somewhat more than 100 percent of the return after costs. The 100 percent answer pertains to the all-inclusive market portfolio and is a mathematical identity—at the aggregate level.
Ibbotson’s point is that because most investors can’t put together a portfolio of individual investments that beat the index, the only driver of returns is the asset allocation of their overall portfolios.
2.90%
I ran a model based on the notion that the share market returns 10% to an investor over the long-term. In reality, this is not the return that ends up in an investor’s bank account at the end of the day.
We are not investing to earn a set of theoretical returns. We invest to increase our wealth to achieve a specific purpose – our financial and life goals. What matters is how much is left in our bank account after all the variables that impact your total return are taken into account. There are many variables that can alter the outcomes that you receive.
Theoretically, with a $100,000 initial investment and $1,000 additional investments every month, in 20 years (with returns reinvested), I would have $1,391,009. Yet if an investor is not careful that 10% return may only be 2.90% which dramatically changes the outcome.
The would reduce the $1,391,009 portfolio to $819,426. This doesn’t include the reduction of purchasing power for the portfolio.
The purpose of this exercise was to understand the different components of a total return. Specifically, the elements that detract from returns. This is particularly important to factor in when you are understanding how much you need to achieve your goals.
Understanding the holistic return ensures that you have more chance of reaching your financial goals. It also makes it more likely that you will pay attention to minimising taxes and fees.
Below are the variables considered and their impact on the final return.
Consider the changes you can make to your investment approach to keep more of the headline returns. There are some ways to add to returns like franking credits. There are inevitable detractors of returns like taxes and fees that can be minimised.
Your behaviour is entirely within your control – you are able to improve your return drastically by focusing on your long-term outcomes and reducing fee and transaction costs that come with overtrading.
Understanding these components can make you a better investor and lift that 2.90% return.
Invest Your Way
For the past five years, Mark and I have released a weekly podcast and written on morningstar.com.au to arm you with the tools to invest successfully. We’ve always strived to provide independent, thoughtful analysis, backed by the work of hundreds of researchers and professionals at Morningstar.
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