Many investors are convinced that their investment portfolios should always go up. When returns don’t meet these unrealistic expectations, they tend to throw in the towel. It’s a mistake to sell good investments just because they are having a sluggish year or struggling through a bear market. You need to invest with your eyes wide open, knowing beforehand what to expect from your investments in both bull and bear markets. In most cases, when your investments take near-term dips, or fluctuate with the market, you should stay invested and hold on.
Most investors ask only one question before buying a portfolio of investments: “What will my return be?” Usually, they answer this by looking at recently posted one-year returns. Stopping at this question will likely leave you disappointed at some point during your investment journey.
In addition to knowing what the returns of your investments have been recently, be sure to ask the following:
- What has the portfolio returned on average over the past one, three, five and 10 years?
- What was the best and worst three-month period during the past 10 years?
- What was the best and worst one-year period during the past 10 years?
- What was the best and worst three-year period during the past 10 years?
- How has the investment performed during past wars, bear markets, terrorist attacks and elections?
As an example, let’s answer these questions assuming you had a moderate portfolio consisting of 75% stocks and 25% bonds, such as a combo of Vanguard Total Stock Market Index Fund (Ticker: VTSMX) and Vanguard Total Bond Market Index Fund (VBMFX), rebalanced annually. You would have enjoyed an average return of 11.98%, 7.43%, 11.14%, and 7.06% over the past one, three, five and 10 years (according to Morningstar) for the period ending 8/31/2017. However, to obtain that 7.06% 10-year return you would have had to endure a worst three-month period watching the portfolio fall 23.45%, a worst one-year period with a drop of 32.03%, and a three-year period that lost 3.98% per year. For the 10-year period ending 8/31/2017, a $500,000 investment into this portfolio would now be worth $999,194.
Once you know the answers to these questions, you can then ask yourself an even more significant question: “If I want the long-term returns this investment or portfolio can produce, can I withstand the volatility?”