Published returns for any investment are based on a single investment over a given period. This isn’t the way most people invest, so their returns are often much different than the published numbers. The timing of deposits and withdrawals effect investment returns.
It’s essential that you look at annual or monthly returns and that you look for consistency. There’s a big difference between an annual return and an annualized return. An annual return is the return on an investment each year. An annualized return is the average sum of those returns.
For example, you could see an investment that has an annualized return of seven per cent over the last five years. It’s highly unlikely that the investment made a seven per cent return every year unless it was a guaranteed investment certificate (GIC), but those days are long gone and might never return. It’s far more likely that the investment had returns each year that were around the seven per cent mark, with some years higher and some lower – or even negative – in order to come up with the seven per cent average.
If you invested a single lump at the start and five years later you took your money out, it makes very little difference what the annual returns were. As long as you held onto that investment, you would get the published annualized return over that five-year period.
However, if in the first year the investment lost money and you panicked and sold, or if the investment went up and you purchased more, then your average return would not be the same as the published average return. The reason: your time in the market was not the same as the published returns time. Missing even one good day or week in the market could have a tremendous effect on your return over the long term. Similarly, missing one bad day or one bad week would increase you returns substantially.
I often find that investors purchase an investment that doesn’t suit or match their intended time frame. Each type of investment has a different recommended time frame. This period varies but generally goes something like this:
- If you need that money back in less than three years, it should usually be kept in cash or some other short-term investment where it’s protected. Options include bank accounts, short-term bonds or term deposits, where the odds of losing your capital are at or near zero.
- If your time frame is three to five years, you can likely afford to take a little bit of risk in the hopes of getting a higher return. Look at conservative or balanced investments and maybe some blue-chip stocks.
- If your time frame is greater than five years, you can likely afford to look at a portfolio that offers potential for some longer term growth. You can do this by adding growth or specialty stocks, exchange-trade funds (ETFs) or mutual funds.
Make sure you review your investment time frame and adjust your asset mix as your time frame changes. This will reduce your risk and enhance your returns over the long term.
Bill Green is an hourly financial and estate planner, public speaker and author of The Success Tax Shuffle. Bill has over 26 years of experience in the financial services industry.