Think for a moment about why we invest in the first place. Do we invest—put money at risk for a future return—to beat the S&P 500 or to make more money than the Joneses? Perhaps that’s the case for some, but smart investors know better.
The real reason to invest is to increase our real wealth. Making more money means being able to buy more stuff, sure. But it’s really about increasing safety and freedom. Increasing wealth is a defensive move, mitigating risks from inflation, adverse circumstances and long life, to name a few. We invest to preserve and strengthen what’s important. We invest for more freedom, if only the freedom from worry.
We care about making money and protecting money. We care about returns, measured in dollars, and risk, defined first and foremost as the potential for permanent loss. Therefore, it’s curious how Wall Street has come to define returns and risk differently.
For Wall Street and the financial advisers on Main Street, it’s all about the relative. Success means returns above a benchmark like the S&P 500. A portfolio down 20% is considered a success if the benchmark was down 25% (the ups and downs in any given year won’t change a financial plan’s rosy return assumption). Returns of 40% are always better than returns of 25%, even if getting that 40% meant one had to risk losing a lot.
Similarly, risk is defined by most in the business not as the possibility of losing money, but by one word: volatility. It’s now widely accepted among financial academia and Wall Street that an asset’s performance relative to the broad market or some other benchmark is the same as risk. (It isn’t.) It’s also assumed that the past price moves of an asset, say a stock, tell you all you need to know about its risk going forward. (It doesn’t.)
It’s as if the majority of the investment profession believes in driving a car looking only at the rearview mirror.
Most of our clients come to us for our absolute return approach: how much money did you make compared to our benchmark of how much money did you start with? We seek to protect money and grow it over time at a good absolute rate of return. This means looking forward, making sensible and rational decisions and thinking about return of our money as much as return on our money! It also means not succumbing to envy and short-term performance pressures.