A short term Treasury Bill has averaged 3.4% annually over the past 89 years (1926-2015)¹. This return was achieved with little or no concern to risk, volatility or liquidity. There appears to be little downside, which usually delivers the equivalent in upside. The inflation adjusted annualized rate of return of the short term Treasury Bill over the same time frame was .50%, barely keeping pace with inflation. The same cannot be said over the past 15 years (2000-2015) where the inflation adjusted annualized rate of return was (-.40%). This, perhaps, is a fundamental reason why millions of investors seek a higher rate of return to fund their financial goals and objectives. While an inflation beating, premium rate of return sounds attractive; capital market investors need to understand the differences between investment options. There are costs associated with trying to earn a premium rate of return. These “costs” include::

1. Volatility
The up and down movement in stock prices can have a strong emotional impact on investors. It’s likely one of the key reasons some investors abandon their financial plan early. Since 1980, the average intra-year decline in the S&P 500 index is (-14.20%)². The data could not be more clear in demonstrating that stock price movement, in both directions, is to be expected. Knowing what we know, it’s interesting to point out that some investors begin to lose confidence in their investment strategy long before the average intra-year decline has been reached. There is also good news to share about the historical data. Of those 36 years since 1980, 27 have ended with a positive return and the average annualized return of the S&P 500 index over this time frame was 11.50%³.

2. Patience
A financial plan can cover a long time frame. Let’s assume a couple in their early 50’s works with an advisor in designing a retirement plan. This typically has multiple stages. In this case, phase 1 would be the accumulation phase which would cover the present until the couple has retired. Phase 2, the distribution phase, would begin at retirement and may last through life expectancy. In this example, the financial plan could easily cover a span of 30 years or more. Even with the right expectations, capital market investors can begin to lose patience when it appears things aren’t going as planned. The S&P 500 index ended years 2000, 2001 and 2002 with negative returns. Extended periods of decline can try our patience. A sound financial plan should not be a “set it and forget it” proposition. The plan is much better served when it is periodically tracked and monitored. Some adjustments made to any plan that covers a long time span can be expected. Stock market declines are not a reason to abandon a plan but may be a catalyst to a thorough review.

3. Time
It is critical for investors to have a clear understanding of his or her plan. This includes becoming familiar with the investment strategy, having clear and realistic expectations, dedicating time for periodic reviews and reporting any unanticipated events to the advisor. These things all require a significant investment in time. I have found that the likelihood of a plan reaching success is increased when all parties (i.e. client and advisor/advisory team) are actively involved and participating. While it is incumbent on the advisor to educate his or her client on plan design and investment strategy, it’s also important for the client to invest time outside of meetings to gain additional knowledge. This can be tricky with so many bad or negative resources in today’s technologically advanced world but most advisors can recommend resources for clients. A good rule of thumb is if the resource you are currently using weakens your conviction to a solid long term plan, change resources and find one that will build and strengthen it.

4. Uncertainty
Since 1926, the S&P 500 Index has averaged 10.0% per year (through 12/31/2015)⁴. Some may conclude, using this index as a benchmark, that their stock portfolio should earn 10.0% per year. While it’s ok to have a target rate of return in mind, it’s important to understand that the figure above is an average obtained over a long period of time. Reviewing the historical data year-by-year, we see a wide variance in returns. In fact, the S&P 500 Index returned exactly 10% only two of the eighty-nine years between 1926 – 2015 (10.10% in 1993 and 10.90% in 2004). Arriving at the 89-year average, the index also encountered a (43.3%) decline in 1931 and a 54% increase in 1933 along the way. It’s not uncommon for an investor to become disenchanted when their account performs negatively over a period of time. This may lead to a deterioration of the conviction once held with the investments and even liquidation of the portfolio. Investors who fail to understand the nature of volatility, the importance of patience, the necessity of time and the certainty of uncertainty are less likely to experience earning a premium rate of return.

While this list may not be all inclusive and only covers non-monetary costs, it reflects some of the most prominent considerations for investors who seek a higher rate of return than offered by short term, fixed rate investments. Understanding the “cost” is critical to the long term success of a plan. Not every plan will succeed without timely adjustments but many plans that are abandoned due to a lack of understanding may forfeit the opportunity to be successful.

- Rick O’Dell