You probably are well aware of my belief that teaching your clients about the foundations of investing is important to maximizing your relationship, right? As I’ve covered in my last couple of posts, educating your clients on issues such as timelines for financial goals and how taxes affect their investments is a great start when it comes to the foundation of investing. The next step in this process is to talk to them about what ‘real returns’ are and how this applies to their portfolio. This might be a tad too far into the weeds for some of your clients who are comfortable letting you make most of the decisions, but I think it’s still valuable information for their overall knowledge base.
Explaining to Your Clients Why They Should Spread Out Their Investments
Before we really get into real returns, I want to issue a warning. When you start explaining this to your clients, they’re probably going to question why all of their money is not going into the investments that have historically performed the best. This is a valid question, but don’t let it throw you off. To explain to my clients, I often find it helpful to use the analogy of a flower garden. Even though tulips might be their favorite flower and the one that always blooms the prettiest, they wouldn’t plant a whole garden of tulips, would they? No, they would plant a variety of flowers that would bloom at various times and complement each other with their colors, shapes and aromas. It’s the same with investing. Depending on your client’s preferences, timelines, and risk tolerance, they need to ‘plant’ a mixture of investments that will create the best overall result. As their financial counselor, it’s your job to show them how to do so.
Average Returns on Popular Investments
Even though you might get the above question when you talk to your clients about the average returns on popular investments, it’s still important to do it. This information is easy for them to access on their own and it’s much better if you can be sitting beside them to help them navigate the information. For this blog, I went back ten years and determined the average annual returns on three types of investments.
The first is large cap U.S. investments. There are large corporations based in the United States like Coca Cola or Google that have more than $10 billion in shares on the market. In the last decade, these have returned an annual average of 14.5%. International (which are considered any stock outside the U.S.) returned an annual average of 7.8% and U.S.-based corporate bonds returned 4.3%.
Your clients will all probably want to be in those large cap stocks, right? But it’s important to show them it’s not that easy. While these had the highest returns in the last decade, they were also the most volatile while some of the other choices provided a more stable investment. But show them that’s also not where the story ends. To get ‘real returns’, you still have to look at a couple more variables.
Determining Real Returns
Real returns are the numbers you get after taking into consideration inflation and taxes. According to the Consumer Price Index, inflation is currently at 2.2%. However, some industries such as education experience a much higher rate, so this also needs to be considered. For simplicity’s sake, though, you should stick with the 2.2% when talking to your clients. When you take that out of the above numbers, they’ll see that the large cap return shrinks to 12.3% while the corporate bonds dwindle to 1.1%. When taxes are taken out of that, the number gets even smaller. These are the actual numbers your clients should be looking at and will give them a much better idea of what to expect with their investments.
So what does this all mean? Your clients will likely have this question after you run through the number with them. Basically, it means that creating a diversified portfolio means they need to have the right combination of risk and returns. If they look confused, assure them that it’s your job to help them choose the right combination and that they don’t need to fully understand all the nuances. At the end of the day, they’ll be grateful that you shared this knowledge with them and usually even more grateful that they can now leave the work to you.
I hope this series of blogs on the foundations of investments has been helpful to you and your clients! If you have any questions at all or would like clarification on the topics we discussed, please leave a question or comment below. I’d love to help out!