With RRSP season upon us, we are being bombarded with advertising and newspaper articles on the importance of saving for our retirement. Savings become investments and investments must be monitored and measured in relation to an individual’s financial plan.
One of the most important investment measurements is performance. An article by Jonathan Chevreau caught my eye recently – “RRSPs – get a handle on risk”. In conjunction with a blog by Larry Swedroe - “Of Course My Returns Beat the Market” - the theme of performance started coming through. Chevreau talks about the importance of having an idea of the return required to make your retirement a reality. And the importance of knowing what return you actually receive is reinforced in Swedroe's blog.
If you don't know what return you need, how can you work with your advisor (or dare I say, with yourself if you claim to be a DIY investor), to build a portfolio that is right for you, and your risk tolerance? And then if you don't know whether you are meeting your target returns how will you know whether you are on track? It's like being on a road trip where you know your destination but have no idea how to get there.
We talk about investing within your risk tolerance. One important point to note is that this can apply to taking on too little or too much risk. If a financial plan works with a target return of, say 4%, and a Monte Carlo or other “what if” analysis shows a very high probability of success, should the client take on more risk than necessary? Conversely, if the plan requires a 7% return to succeed and the client has a low risk tolerance, how can the portfolio be adequately structured? A higher equity allocation may cause so much anxiety in volatile times that classic behavioural mistakes result. A re-evaluation of basic planning assumptions may be more appropriate - maybe those extra travel dollars in the early years of retirement can be pared back.
The importance of having a plan and reviewing it regularly can't be stressed enough. After the downturn in 2008, we updated our clients' retirement projections to reflect the impact of lower portfolio values, and lower expected returns going forward. Since then, we have compared actual to projected at the end of each year. In general, our portfolios did not meet the target 4% return in 2011. But the fact that we had higher than target in the past two years means that, on a cumulative basis, we are still on track.
We know the target return will not be achieved every year, but by keeping an eye on where we planned to be versus where we are, at least we have a chance to keep our perspective when we have an "off" year. Having a plan helps to set expectations and therefore helps to manage our behaviour around our money.