Do You Have Unrealistic Portfolio Return Expectations?

Walter Storholt:

Do you have unrealistic portfolio return expectations? We’re going to talk about it in this episode with Tyler Emrick, Certified Financial Planner, to explore that disconnect between an individual investor’s portfolio return expectations, and then also what historical performance tells us, and how, if the capital market assumptions of the big institutional investors are right, individual investors could be setting themselves up for disappointment. We’re going to break it all down today. Tyler’s going to set us up really nicely. Coming up next, stay tuned, this is the Retire Smarter Podcast.

Hey, welcome to Retire Smarter. Walter Storholt here with Tyler Emrick. As I mentioned, a Certified Financial Planner at True Wealth Design. Check us out at truewealthdesign.com. Tyler, it is great to be with you on today’s episode. My friend, what is going on in your world?

Tyler Emrick:

Yeah, happy to be here, Walt. I’m doing all right, hanging in there. Kind of riding a little bit of a high from the weekend. My wife had a very important birthday this past weekend and we were able to have some of our long-time friends in town and enjoy some good weather and some good conversation and hang out. So it was a really good weekend for us and now we’re back into…

Walter Storholt:

Good on you for keeping that very vague and not getting into too many… I was getting nervous for you as you were going down that road a little bit.

Tyler Emrick:

Yes. No, I prepped it. I did, I did. Actually, I originally was going to just throw it out and say the age and kind of go into it, but I thought better of it.

Walter Storholt:

So I would’ve had to trigger the Egghead alert on you but for different reasons than we usually play the Egghead alert.

Tyler Emrick:

Well, she listens and she probably would’ve given me a swift hit to the back of the head if she would’ve had…

Walter Storholt:

Right upside the egghead.

Tyler Emrick:

Yeah. I would’ve got it. But no, good weekend. Good weekend. How about you, man?

Walter Storholt:

Glad to hear that. Same here. We’re going to get a little beach time in, leaving shortly after we finish today’s podcast. Not too long, so…

Tyler Emrick:

Nice.

Walter Storholt:

Get a little sun on the skin and come back refreshed for our next episodes. That should be a lot of fun.

Tyler Emrick:

And you know, grew up here in good old Cleveland, really close to us here at our home office in Akron. We got a little beach too right up here on the Great Lakes. Maybe not quite to the degree that you’re going to have in front of you and you’re going to get enjoy, but certainly got our own little beach on the lakefront too.

Walter Storholt:

Well, I know you are not very far from Cedar Point, and it’s been a dream of mine since I was a little kid to go to Cedar Point and go to the amusement park and ride all the rides and stuff like that. So one of these days, I’m still going to make it out to Cedar Point.

Tyler Emrick:

Oh, you absolutely should. Yeah, it’s a good time. And they sell Dippin’ Dots too. It’s like the best ice cream ever.

Walter Storholt:

You know you can get Dippin’ Dots at other places, not just amusement parks?

Tyler Emrick:

I do. It’s like a big thing in the family. It’s

Walter Storholt:

It is tradition though, right? Getting Dippin’ Dots at the amusement park? It kind of goes hand in hand.

Tyler Emrick:

It is. I get to crack jokes on quite a bit from some select family members when we are at the theme parks or wherever that they have. But yeah, Dippin’ Dots. Yeah, they get me every time.

Walter Storholt:

There is something about them that just makes them extra special. I don’t know what it is. Well, it’s really funny, not to get too far off track, but I grew up in North Carolina and every time we went to the beach, and then we eventually lived at the beach when I was in high school, I would always see, every summer, every other car had an Ohio license plate. And I was like, just everyone from Ohio comes to the North Carolina Beach for vacation.

Tyler Emrick:

We vacation. Myrtle Beach. Yep.

Walter Storholt:

And it was so funny, everybody from North Carolina wanted, at least kids that were my age, we all wanted to go to Cedar Point. So that was the trade, it felt like, of Ohio versus North Carolina. You guys come to the beach, we want to go to your amusement parks.

Tyler Emrick:

Cedar Point. Yeah, that’s a good one. There’s no doubt about it.

Walter Storholt:

Yeah, for sure. Well, let’s get into our main topics today and dive in here, Tyler. We set it up, with unrealistic portfolio return expectations. We want our listeners to ask themselves that question, and it’s kind of a deep topic because it involves institutional investors and what they’re setting for us, historical returns, and lots of good stuff here.

Tyler Emrick:

It is. And I think as I thought about the setup for today’s podcast and what we were going to talk about, a couple things came to mind, and the first thing is, is just really that relationship between high expectations and what really actually happens in reality. I don’t know if you read this book, but Charles Dickinson, The Great Expectations, was that on your high school reading list at some point in time?

Walter Storholt:

I never read Great Expectations. For whatever reason, that one didn’t make it through our curriculum.

Tyler Emrick:

I don’t know if it still is, or maybe that was just a one-off from ours, but…

Walter Storholt:

Maybe we had to do Beowulf instead or something like that.

Tyler Emrick:

Well, the story was about Pip and Pip inherited quite a bit of money from this secret benefactor. And as you could imagine when he got this money, his views of this fortune, as a stepping stone to get the girl of his dreams, live the life that he wanted. And to nobody’s surprise, well, it didn’t make him happy and he eventually lost everything. So it’s like a…

Walter Storholt:

A story that’s been told in many forms over time now, right?

Tyler Emrick:

Oh, for sure. Yeah. It’s like a 500-page reminder of why you shouldn’t bother playing the lottery, right?

Walter Storholt:

Yeah. Your life will basically fall apart based on the track record of previous winners.

Tyler Emrick:

Don’t do it. Yeah, high expectations, reality doesn’t quite live up to it. And of course…

Walter Storholt:

There’s a whole business lesson behind that, right? Like under promise, over deliver versus the other way around, that kind of thing.

Tyler Emrick:

Yeah, I did a couple searches on the internet trying to find and make a connection. I mean, Charles Dickinson came to mind for me, but I got to bring up too, and I think I mentioned this to you before we started here, but I did a search, right? Expectations verse reality, and this meme came up and it just cracked me up. It’s just two pictures right next to each other, and at the top, it says ‘New Year’s resolution’, and on the left-hand side it’s got this couple running down a track, ‘expectation’, they’re having a good time, they’re working out, and then of course, right next to it, it’s got this guy laying on a couch, Cheetos popping out of his mouth saying ‘reality’ and just… Hey, all the good intentions in the world, New Year’s resolution, good to exercise, but not what really happens.

So I think when you think about that, and that happens so often to us, we see that in our portfolio and our return expectations as well. I mean, I was just sitting down with an individual over the past few weeks and we were talking about just the portfolio and the performance and he came out and just said, “Hey, I really just really would like to see about an eight to 15% growth over the next few years.” When I hear something like that, I mean, well, first off, it’s not uncommon, at all, that individuals expect returns like that from their portfolio. A company called Natixis, and I might be mispronouncing that a little bit, but they surveyed a bunch of individual investors talking to them about returns and return expectations, and the survey came back that the investors expected a little over a 15% annualized return from their portfolio. That’s about twice what financial professionals expect from the portfolio. So wildly different and a huge disconnect there.

Walter Storholt:

And we’re not talking a 1% difference here in expectations. That’s double, more than…

Tyler Emrick:

Not at all. And the author of the survey who put it together even mentioned how most individual investors, I mean there’s a very high percentage of them, well over 90% or so, don’t even do as well as the market averages and tries to dive into this bias or this thought that, well, what is a reasonable return expectation? And he kind of attributed it to a number of words that, hey, we’ve had a decade of really out-sized investor returns or stock market returns, and a lot of those investors have been conditioned to just expect higher returns because they think that’s the norm. And I would say this expectation isn’t just in portfolio returns or certain asset classes. You got to be careful with real estate as well. I mean, the same individual that I was talking to has a very nice real estate portfolio, and his comment was like, “Hey, I’m getting around five to 7% per year from my real estate.”

And when you try to unpack real estate returns, I think there’s a lot that goes into it, but what he was alluding to is, “Hey, I’m getting these rents and they’re coming out to about that five to 7% return per year.” But what he was really not alluding to or not including in his calculation that, well, none of his properties were Mark To Market or trying to be sold so he wouldn’t have to realize any losses or anything like that due to the market downturn that we experienced last year. You know, you look at a public real estate fund, we call those REITs. Vanguard’s got a very big one, it’s VNQ. Last year, that portfolio had a very similar positive rental income, but for the year, the particular investment was down a little over 25% in 2022. So not only can that disconnect happen with return expectations, but sometimes even with our own portfolios, understanding where your return’s coming from and seeing the whole picture, there can be that dislocation there.

And we don’t want to lose sight of that, right? Because in his situation, if he would’ve sold that real estate, it’d be interesting to see if he would’ve had to mark those down like a lot of those other investments do when they Mark To Market each day.

Walter Storholt:

I definitely think about that a little bit from the terms of just what you’re exposed to in a certain period of life can lead you, I’m sure Kevin would throw out exactly what kind of bias this is. Maybe it’s just recency bias. I graduated in 2009, so 2008, it happened during my junior into senior year, going to the job market in ’09.

Tyler Emrick:

Tough time.

Walter Storholt:

Nobody’s hiring, tough time, totally shapes my first several years of work life and probably increased my work ethic and just how seriously I took my job and my career. I mean, I was a weirdo. I kind of already took it very seriously as I worked five jobs during college, but still, helped shape all of that, versus if I just rolled out and been like, “Y’all are fighting for me to come work for your company.” Someone who maybe gets exposed to that at first, totally different expectations for many years, perhaps. Same thing with these investments, it sounds like.

Tyler Emrick:

Sure. Sure thing. Well, and I think when I start these conversations, because we have them all the time, yeah, I really like to really paint that historical perspective for individuals because if your time horizon or what you’re looking at is very short, we can really lose sight of that. So we take a look at the stock market, for example, and let’s say we just go back over the last, roughly, a hundred years or so, the US stock market has returned about 10% per year during that time. But what’s fascinating to me is, okay, it’s returned about 10% per year on average, but it’s done it in an extremely volatile way. I mean, there are years that the market got upwards of 50% positive return and then there are years where it’s lost 40%. That is some extreme volatility in a very large range as we start thinking about portfolio values and your retirement savings and how much they can fluctuate on a year-in, year-out basis.

And if you get down into the weeds a little bit, in the last a hundred years, if you try to piecemeal and pick out those years that the market did return close to the average, close to 10%, there is just six years, roughly the last hundred, where the market actually returned close to 10% per year. All other years, it’s been very different than that historical average, which I think just really brings home that point that the stock market can be extremely volatile from year to year, and it’s very, very hard to predict what the market’s going to do in any given year. I think that’s why many investment professionals and money managers are so adamant that it’s very difficult, almost impossible, to time the market. But what I do think is clear, when we go back through the data, is that staying invested is going to be the way to go. And the reason why we go on that is because if you look back over that last, say, last a hundred years, stock market returns, 71 of those years, the stock market was positive.

So what that means is that more often than not, if you’re staying invested and you’re riding it out, you’re going to come out ahead. There’s no guarantee of course, but you can really get yourself into trouble if you start to time it. I had a family that I started working with a little over a year ago now, and they had actually worked with a financial advisor for a number of years, and during 2020 and 2021, with all the Covid concerns and the market volatility, their advisor actually moved them mostly to cash. And if we look back, we can clearly see how well the market did in 2020 and 2021. I mean, we’re talking double-digit returns in both years. And when you get into a situation like that, I think it’s very clear that just because you have a financial advisor, doesn’t mean that you’re shielded from bad investment management. I think our job as investment professionals is really to try to take the emotion out of investing and not get caught up in it.

But if us as advisors do not have a solid process and rules set with the way we develop portfolios and manage them, then we can get into just as much trouble as individual investors and that emotion can take over. In that scenario, I bet their advisor, it was very clear to him at the time like, “Wow, the stock market’s going to do terrible. Look what’s happened with Covid. The economy shut down.” And that was a wrong assumption. And if you have an advisor that can have that much leeway and make those assumptions and make those changes where they pull you out of the market or try to put you all in, that’s getting into that timing situation, and very, very rarely, if not at all, does the data show that that comes out successful. And it’s extremely, extremely hard to do.

So if you do work with a professional, I think it’s extremely important that if you haven’t asked them, “What is your investing process? What rules do you use when you’re managing my portfolio to make sure that we don’t get too far making a bet one way or the other?” Because if that bet is wrong, that can really come back to bite you.

Walter Storholt:

It’s great to illustrate that too.

Tyler Emrick:

Yeah.

Walter Storholt:

Because of so much focus, I think, the financial world, especially when it comes to retirement, does seem to be on the other end of the spectrum. Like, make sure you’re not taking too much risk in the market. But boy, you can also take too much risk being out of the market in some of these examples.

Tyler Emrick:

Well, how easy does it sound if your advisor comes to you, “Hey, let’s just sit on the sidelines for a minute,” Right? I mean, “Oh, it’s too much going on.” And time and time again, the data shows that that is just too hard to do. I mean, even from our own perspective with True Wealth Design and our management, we look back on 2022, we didn’t love the return expectations in the bond market, or we have a process in place that says, well, hey, we can only take our bond exposure down to a certain minimum level before our rules step in and say, “Hey, you can’t just completely eliminate bonds from a portfolio,” Because that goes against everything that we invest in our principles when we go and develop a portfolio, and all the data shows that you don’t want to overextend yourself and make those large bets. You can get yourself into a tough situation. So we run into it all the time as well. And we’ve done a lot to put rules and processes in place to eliminate a lot of that guessing and not get ourselves in that situation.

So I think that’s important. If you haven’t had that conversation with your advisor, you absolutely need to understand that to kind of avoid some of those pitfalls.

Walter Storholt:

Well, there’s certainly the looking back at the historical perspectives and then the other side of the coin looking ahead, right?

Tyler Emrick:

It is, right? And as you look ahead, I mean, there is no crystal ball. I mean, boy, if you did, we’d all be rich. So there is no crystal ball and forecasts aren’t perfect, but if we look at some of the largest institutional investors and what their return expectations are… I mean, one of the largest investment money managers in our industry is BlackRock. I’m sure many of the listeners have heard the name before and maybe have had some investments through BlackRock. I mean, they’re managing a little over eight and a half trillion in assets for institutions, families, investors, and so on and so forth. So all these companies such as BlackRock, JP Morgan, Chase, they put out what they call capital market assumptions, which is their best guess as to what should we expect over the next five years or next 10 years from a return standpoint in each of these different markets?

So if you look on BlackRock’s website, you go to their capital markets expectations and you go to US large cap, their return expectations over the next five years is for the US stock market large cap to average a little over seven points a half percent per year, which, historical is at 10 so we’re definitely below that, at least in their eyes as they kind of look at that. So you expand out your picture a little bit. I mean, the US market isn’t the only one to look at, and we go and say, “Well, what are the return expectations for international companies or emerging market countries?” I think the return expectations were not, I think, the return expectations are a bit higher. When you look at BlackRock’s forecasts, they’re expecting somewhere between 10 and 11%, depending on the country over the next five years, annual average return. So that’s what? Almost 3% higher than what the US market, their expectations return are for them over…

Walter Storholt:

Is that surprising to you?

Tyler Emrick:

Well, not necessarily to me, but I think it’s surprising to a lot of individual investors or a lot of individual… Not just individual investors, but a lot of investors in general. You know, you look back over the last decade and the US market has been the clear winner. It’s outperformed all these other countries and it’s done very, very well. And kind of like what you alluded to when you came out of college after 2008 and the job market was tough and that impacted and reflected on you and your work ethic, well, from an investment standpoint, you go through a decade of outperformance in the US market, that’s going to affect your biases a little bit if you haven’t studied and gone back a little further. Because if you would, the decade prior, 2000 to 2009, we consider that the lost decade where the US stock market had very poor performance and international and emerging markets outperformed by a significant margin.

So those time periods and not losing sight of perspective will really help you as you’re kind of making these decisions and looking at your portfolio and trying to decide, well, where’s my risk at and what should my return expectations be? So if we kind of circle back to that conversation I had where the individual said, “Hey, I’d like to get somewhere in the order of eight to 15% return over the next few years.” Well, historically speaking, that’s above the historical stock market average of 10. And when we add in the volatility that we historically experience in the stock market, that becomes a very, very tall task. And then we kind of look at forward return expectations being even lower. And if we have a bias towards the US, then it’s, well, 7.5%. That falls way short of what his expectations are. So I think taking a look at the historical and forward-looking projections and developing some type of reference point to help make those expectations or bring them to light is really helpful and can be impactful as you’re kind of having these conversations, so that’s what I try to do.

And I don’t know where the return expectations come from, because I think depending on who you’re talking to, they can be vastly different. I mean, I think back to even my own situation. Just a few weeks ago, I was talking to my buddy and he brought up just how well he had done in Tesla stock. I mean, Tesla was up, I don’t know, somewhere around 140% year to date. I mean, that sounds pretty darn good, right? I mean, sign me up for that.

Walter Storholt:

I’ll take it. Yeah.

Tyler Emrick:

Yeah.

Walter Storholt:

Absolutely.

Tyler Emrick:

But you look at Tesla, for example, and you just go back and look at last year in 2022. I mean Tesla was down 65%. So for an individual that’s held Tesla stock for the last year, yeah, they’re up 44% year to date, but going back just over the last 12 months, their actual return’s still negative. I mean, they’re down a couple percent in aggregate, even with the big uptick this year. I mean, you look at just an MSCI, All Country World Index, which is a global market, performance is up about 15% during that same time period. So it goes back to that old adage, right? “Over 90% of individual investors don’t even beat the market.” So you could even have a story where you’re maybe bragging a little bit and being happy, but if you didn’t time it perfect, well, it’s not going to really work out as well as what they might be saying, or maybe they’re not telling the whole story.

Walter Storholt:

Yeah, I can actually raise my hand on this exact issue.

Tyler Emrick:

Come on, Walt.

Walter Storholt:

And it’s exactly what you just mentioned.

Tyler Emrick:

No way.

Walter Storholt:

No, no, no. It’s actually really, really funny that you mentioned this. So we have an account, it’s like an old… I don’t know, I think it’s a Roth IRA, I can’t remember off the top of my head. It’s just something that my wife had then, or maybe it was an old work account or something. It’s only got $2,000 in it or something like that. So it’s not our main where we’re… And we’re not currently contributing to it, but it’s kind of locked in where it is. I don’t know, it’s just one of those things. I’m the perfect case study, I need to roll that into something or do something with it, right?

Tyler Emrick:

Yeah, yeah.

Walter Storholt:

But anyway, I was like, all right, well this thing’s not doing anything and it’s not going to be generating long-term dividend income off of this. So I was like, oh, I’ll just take a flyer, just throw it into some Tesla stock just in case Tesla goes through the roof. And then Tesla tanked. It went down 65% as you just mentioned, but I was at least like, all right, well I’m not going to sell it at a loss. I know it’ll come back eventually, we’ll just let it hang out. So it was fun…

Tyler Emrick:

You got a few biases in there. Oh, we could talk through all of those decision makings a little bit, but that’s funny.

Walter Storholt:

You’re just making me chuckle because I’m like, “Yep, I did that. Oh, is it the same stock? Yeah. Sure thing.

Tyler Emrick:

Well, it’s easy to lose perspective, isn’t it? I feel like it can be, especially when you can pick and choose particular time periods to make things look maybe a little bit better than they are or justify the investment to yourself, right?

Walter Storholt:

Yeah.

Tyler Emrick:

When some of that happens. For the podcast, when I was, again, prepping for it and kind of thinking through what we wanted to talk about today, I pulled up our hobby accounts. So we have a little over 5 million of what we call hobby accounts for our families where we hold some stocks for individuals and maybe they make a couple trades in there and they kind of manage it themselves. So not an insignificant amount of money and it’s over 5 million, and there’s a number of different accounts in there, but I just pulled back the three-year returns of those accounts and they’re a little under 3%. And I compared it to the benchmark, just the Russell 3000 benchmark, total stock market benchmark, was up almost 14%. So there’s about a 10% difference in the performance of those accounts versus just buying an individual index in the Russell 3000. So it’s fascinating to kind of see how all that trading or that individual stock risk and things like that might not work out all the time or be as good investments as what they think.

And we run into it with Crypto. I mean in 2020 and the run-up that crypto had, you can, very similar to Tesla, see the fall that it had in 2022 where crypto was down 65% and then it’s up about 76% this year. And when I say crypto, I’m just saying Bitcoin, but we get those questions quite a bit. And they’ve settled down over the last 18 months but boy was it a pretty hot topic asking about crypto and some of the returns. And I think understanding that volatility and understanding the risk there is extremely important.

Walter Storholt:

The more I’ve tried to manage my own stuff and be more active with it, to be more exciting or something like that and try to do some of these things, the more I’m like, “Yeah, I just take boring and predictable. Can I get some more of that please?”

Tyler Emrick:

Well, I agree. We’re in the to-dos, right? As I think about, well, what is a better way or what way do we think is a better approach? Well, I think really taking a step back and understanding like, “Well, what am I trying to accomplish from a financial standpoint? What are my goals? What do I want to do with this money?” And really project it out and say, “Well, what rate of return do I need to get to on my money to accomplish those goals?” Is the best starting point. And then what you can do is, you can kind of back into your portfolio from there. You can say, “Well if this is the rate of return that I need to get on my money to make everything work, why don’t I construct a portfolio that has historically performed and met that return expectation?” And then create a diversified portfolio that will be able to meet that return with the least amount of risk possible, right? To smooth out your ride and eliminate some of that volatility.

And then of course, once you’ve got that set, now it’s taking a look at your benchmarks and monitoring that portfolio and making sure that it is performing the way that you’re expecting and you’re rebalancing it and you’re doing all the good things that you should do as a steward of your money, kind of managing that portfolio going forward. And if you don’t feel you have the time or want to be getting into doing that, well, I think that’s where investment professionals such as ourselves come in and that’s what we do for the families that we work with.

Walter Storholt:

It sounds like our listeners and probably myself need to be picking up the phone and calling True Wealth Design so we can kind of work through some of this Tesla problem, we’ll call it…

Tyler Emrick:

Tesla problem. I like that.

Walter Storholt:

Having to shine the light a little bit back to my own situation on this one.

Tyler Emrick:

Sure.

Walter Storholt:

Really helpful breakdown. Thank you for all of this today, Tyler. And it does bring up the point, if you want to talk a little bit about your situation, are your expectations… That was the question at the top. Do you have unrealistic portfolio return expectations? We uncovered some of the reasons why that may be the case. If that happens to be you, don’t hesitate to reach out. Talk to Tyler, Kevin, and the great team at True Wealth Design about your portfolio, about your financial life, and what’s going on. You can actually have a 15-minute call with an experienced advisor on the team to see if you’d be a good fit and where you might be able to be helped out. All you have to do to set that up is go to truewealthdesign.com and click the ‘Are We Right for You?’ button. That’s it. Go to truewealthdesign.com and click that button. You can also call the number eight five five T W D Plan. That’s 8 5 5 8 9 3 75 26 and have a chat that way as well.

Tyler, thanks for all your great thoughts on today’s episode. You can go back to looking at memes now and…

Tyler Emrick:

Will do.

Walter Storholt:

We’ll look forward to another good episode with you soon.

Tyler Emrick:

Sounds great.

Walter Storholt:

All right, thanks so much. That’s Tyler Emrick, Certified Financial Planner. I’m Walter Storholt. Thanks for joining us. This was a lot of fun. We’ll see you next time on Retire Smarter.