Expectations Vs. Reality — Here’s Why It Matters For Investing Success

A few years ago, my wife and I started an annual “Financial Retreat”. This is where we take a small vacation to relax and discuss our financial goals for the upcoming year, five-years, 10-years, etc.

During our retreat, we cover a lot more than just retirement planning. We talk about our yearly budget, what vacations we would like to take (and earmark some savings for those occasions), any large purchases or events we might incur… We ensure we’re maxing out our IRAs, taking advantage of matching 401(k) contributions, maxing out our Health Savings Account (HSA), that we’re on track for how much we need to have saved for retirement… And of course how much we can stash away for those rainy days.

It’s great for us to get on the same page and make sure we understand where we are, and where we need to go. If you’re not already doing something like this, I highly recommend it.

But one year, during the discussion of our retirement accounts, my wife caught me off guard…

How Much Is Good?

You see, I manage our IRAs. And that particular year was a fantastic one in terms of market performance. The S&P 500 rattled off a 29% gain (2019). Many of her holdings performed even better during the year, up 31%, 46%, 50%, and 57% to name a few.

With her IRA, I practice what I preach over in my premium services. I let our winners run and cut our losers short. And it worked like a charm…

I thought I did a pretty good job with that in her portfolio that year. In fact, we only had one loser, which I cut short for only a 16% loss. All other closed positions were for a gain, and she had no losers sitting in her portfolio when we had our talk. So naturally, I was excited to share these results with her. But my enthusiasm wasn’t met with equal zeal…

“That doesn’t seem like much… it seems like we should be making more…” was her response.

Dumbfounded, I assured her that a 20%-plus return in a year was indeed good.

Now, understand my wife is sharp. So this was a good reality check for me. I knew that if she “expected” these sorts of results and better, then she’s probably not the only one.

Expectations Vs. Reality

A recent survey found that Millennials expect to earn an average annual return of 13.7% from their investments. And they expect to earn these returns while being much more conservative than prior generations.

In other words, Millennials don’t want to risk their money. But they expect to earn double-digit returns.

These lofty expectations are likely due to the results of the past decade, which has produced outsized returns. It’s also likely the culprit for why many investors have sky-high expectations for their investments.

Consider this: In 2020, when the world practically shut down due to the Covid-19 outbreak, the S&P 500 ended up with a positive return of 16%. Incredible. But I’m here to tell you , those expectations should be adjusted…

As you can see in the graph below, the compounded average return — including dividends — of the S&P 500 since 1871 is 9.2% (blue bar) — when adjusted for inflation the return falls to 7%. However, over 10 years spanning from 2010 to 2019 — thanks to a raging bull market at the time — that average return jumps more than four percentage points to 13.5%.

Is it a coincidence that most people in my generation have the same expectations as what the market did during their formative adult years? I don’t think so. But the truth is, the market goes through some pretty wild swings. And even though the trajectory is up over the long-run, investors need to be prepared for some volatility and some inevitable down years.

To see what I mean, take a look at this chart showing the S&P 500’s historical returns by year…

Source: MacroTrends.net

Closing Thoughts

With investing — as with most things in life — it’s all about managing expectations. If you expect the market to rally 10%-20% every year, then I’ve got some bad news for you… you’re going to be disappointed.

Many folks begin their investing/trading careers with expectations of making easy money and striking it rich overnight. They expect to easily beat the market every year… win every trade. But the problem with this line of thinking is that they can’t admit when they’re wrong. They hold onto losers and often watch them swell into larger losses, because if they sell at a loss, it concedes defeat. They can’t handle the failure.

But as I’ve said many times before, selling a loser short is actually a win. It’s a win against a larger loss. You need to be okay with booking a loss once in a while. It’s going to happen. It’s part of the process. Just keep those losses small and you’ll be able to stay in the game — and build wealth — much longer and quicker.

As one of the all-time heavyweight champion boxers, Mike Tyson famously said, “Everybody has a plan until they get punched in the mouth.”

As we work our way through this year, remember keep your emotions in check. Part of this is keeping your expectations in check as well. Instead of wondering if the market will deliver another 20%-plus year, focus on keeping the profits you earned last year. Focus on cutting losers short and letting winners run.

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