Roger Wohlner
I contend that setting your expectations prior to investing is one of the most crucial aspects for investing success.
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As an example, you decide to purchase IBM stock. Why? What are your expectations for this investment? Do you expect IBM to outperform the broader market? Do you expect IBM to outperform the stock of its various competitors? Do you have a price target for IBM over some period of time, for example a 50 percent gain over a three-year period?
My point is that having expectations for this holding will help you to know if this investment is performing as planned. A set of expectations allows you to assess how IBM is doing. What happens if IBM stock appreciates 50 percent in one year? Should you sell? Maybe, but the better answer would be to establish a new set of expectations. If you feel the stock still has a way to go, perhaps you hold. If your expectation is that the stock will stay flat or go down, then perhaps it’s time to sell.
Let’s say you decide to invest in the Vanguard 500 Index mutual fund. Implicitly, your expectation is that the fund will track the performance of the S&P 500 Index, less the fund’s expenses. On another level, why did you pick an index fund vs. an actively managed mutual fund in the same fund peer group? Perhaps your expectation is that the low-cost, passively managed fund will outperform most active managers over time. You can track this expectation by looking at the fund’s performance vs. its large-cap blend peer group over time. If the fund is consistently above the median of the group in performance, it is meeting your expectations. If not, perhaps it is time to reevaluate your reasons for holding the fund.
This also applies to your investment portfolio. Your asset allocation should be based on a set of expectations. Your allocation to various types of investments—whether stocks, bonds, cash, or other groups—reflects both your expectations for each asset class and for your portfolio as a combination of these asset classes.
One expectation might be that the portfolio will perform in line with a blended benchmark comprised of market indexes in proportion to your allocation to each respective asset class. Or perhaps you are expecting performance that is some percentage of the S&P 500 with a lower level of risk. Having a defined set of expectations allows you to track how your portfolio is doing and make adjustments as needed.
To be clear, investment expectations are not about predicting the market, but rather about expectations as to how individual holdings and your overall portfolio will perform against some benchmark. Think of this as having a destination in mind prior to embarking on a car trip. As the saying goes, you won’t know when you’ve arrived if you don’t know where you are going. Investing is much the same.
Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides advice to individual clients, retirement plan sponsors, foundations, and endowments. He recently cofounded Retirement Fiduciary Advisors to provide direct investment and retirement planning advice to 401(k) plan participants. Follow Roger on Twitter and LinkedIn. Roger also blogs at Chicago Financial Planner.
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