The Difference Between Investment Return and Investor Return

Investing is a key component of your financial plan.   To be successful, one of the most important traits you need is intestinal fortitude.  Reaching for return introduces some emotional stress, and sometimes that stress can be Intense.  Big decreases in value cause many people to sell investments – and most do it when they shouldn’t.  Today, we talk about the difference between investment return and investor return.

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Defining Investment Return and Investor Return

There is a difference between investment return and investor return.  Investment return is a look at the total return of a stock, index, or fund for a defined time period.  It includes the change in price and the return from dividends.  It assumes no cash flows in or out during the time period.  In other words, it is the return generated as if you held the investment the entire time.

If you are looking at statistics for a specific investment, what you will see is the investment return.  

On the other hand, investor return factors the decision-making of the person who owns the investment during the time period.  Did they buy more? Did they sell?  Those cash flows will alter the rate of return an investor sees on their statement.  Well-timed decisions could make investor return higher than the investment return.  Poor decisions could make the investor return worse than the investment return.

If you are looking at your statement, what you will often see is your own investor return.

Often There is a Difference

Every year, Morningstar compiles a study called Mind the Gap.  It compares the return of a specific investment to the returns adjusted for cash inflows and outflows of the same investment.  The idea is the cash flows will approximate the buy and sell decisions made by those individual investors.  Here are some interesting data points.

• Over the past 10 years, the difference between investment return and investor return has been roughly 17%, or 1.7% per year.  (This is similar to previous studies.
• The more volatile the investment, the larger the gap.
• Asset Allocation funds—funds that own multiple asset classes—tend to have smaller gaps.
• International stocks have shown a larger gap than US funds.

Why The Difference?

In the past 30 years, we have seen two instances where stock prices have declined roughly 50% or more, along with other bear markets.  We have also experienced two of the best bull markets ever recorded.  Some people make good choices, while others make poor ones.  Why the difference?

Our brains are hardwired to protect what we have worked hard to accumulate.  When we see account values decreasing, our instincts tell us to protect what we have.  Behavioral finance research has shown account losses feel twice as bad as gains feel good.  The emotional responses to sell in a bear market is very strong—even when the rational choice is to do nothing.  

Successful Investing is 90% Mental

Hall of Fame catcher, Yogi Berra always provided some interesting quotes.  He once said that 90% of playing baseball is mental, the other half is physical.  You can say similar things about being a successful investor. Consider one of the most successful stocks of the past quarter century, Amazon.  Amazon went public in 1997 and has generated amazing returns. It would be easy to use hindsight to say, "I wish I would have purchased 1,000 shares back then."  But consider what you would have had to endure to get there:

• At least two price drops of 90% 
• A few 60% declines
• Multiple times when the value was cut in half (including 2022!)

In 1997 and during the dot com bust, nobody knew Amazon, then just an online bookseller with no profits, would be what it is today.  And if you had the intestinal fortitude to ride through all of that...your rewards would have been tremendous.  But you need to ask yourself, could you watch a $10,000 investment drop to $1,000 (or less) and still have the conviction to hold it or buy more?

Emotions Can Lead to Mistakes

Market downturns of any magnitude are hard on all of us.  Nobody likes to see our account values fall.  Many members of our team have seen two 50% decreases in their careers.  But past bears have all recovered and gone on to create new wealth.  As investors, we have an emotional attachment to our money.  Unfortunately, this often leads to mistakes - selling at lows, only to buy the same positions at higher levels in the future. 

One of the many areas we believe we add value is helping you avoid those costly errors.  As planners, our emotional investment is made in helping you achieve your long-term goals.  Because we view investing through a different lens, we can help you focus on creating the retirement you want or building a multi-generational legacy.  You don't have to navigate the difficult times alone. 

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