Transcript

I'm Stephanie Mathis with Michael Yip on MYWP's MarketCast. Hey, Mike. I'm curious, what would you say is the top request you get from clients, what they want the most?

How much money are we making, can we be making?

Show me the money.

Yeah.

That's what they're saying. Say it with me.

Show me the money. Show me the money.

So we're talking about rate of return today and that profit that we all want to make on our investments. And you are promising to tell us what's reasonable, what's ridiculous, possibly illegal, and what might be an even better measurement than the rate of return.

Yeah, that's what I'll try to talk about. But I'm trying to get over the fact that this Show Me The Money thing from Jerry Maguire.

Now I know. It's one of the top 100 most quoted lines and the only one having to do with money in case you're looking for useless trivia.

[LAUGHTER]

What is a good rate of return?

The way I'd like to frame it is, what's a reasonable rate of return to expect? A reasonable rate of return is somewhere between 6% to 8% historically, on basically a diversified portfolio, and that number does not come out of thin air. It's supported by decades and decades of returns. Just to give listeners a bit of context, very, very long-term returns in the S&P 500 are around 10% inflation adjusted and bonds, 10 year treasury bonds, are about 5% or 6%. So if you take 50% of each and you add it together and you divide it by 2, that's about 7.5% So in general, is the number 15%. No, it's not really supported. Is the number 2%. No, it's not supported. The number is somewhere between 6% and 8%.

Is it as simple as people asking you about the rate of return because they want to make money?

Yeah, I think they ask about the rate of return because I think they want to know if they'll be OK. I think knowing when a client comes to us or a client that's thinking about joining the practice comes to us, they want to know is the rate of return that we should expect good enough for us to have the life that we want to have?

Do you discuss what clients have made in previous years or in particular years?

Yeah, this is a tough question because people that are new to our practice sometimes or are trying to get to understand our practice will ask, what was your return last year?

I think it's a common question.

Yeah, and the background there is that there is no one rate of return for our clients. And the reason for that is because I don't run a fund. When I did run a fund, we had one set of investments for all the investors that invested in that fund. Everybody owned an equal amount of that fund. And the return on the fund was the return that you got as an investor. That return was audited by an account, and we had the regulatory ability to put that out there as our track record. So sometimes, again, people ask about track record because they hear that term. When you come into a wealth managers practice, we're not allowed to say that our practice produces x rate of return. It's in violation of our own regulation.

This was that illegal bit I was hinting to. So can you tell us more about that?

I think that there's a wide variety of advisors out there that will lead with return because they know that return is psychologically connected to the pleasure and pain center of the brain. But if you walked in and I was unscrupulous, and I realized that you want to hear the biggest number I might say, you know what, I think a 15% rate of return is reasonable, knowing full well that may or may not happen. But I might have a higher chance of winning your business.

But you're saying you're not allowed to say something like that.

You are not allowed to say that. But I do think that happens out there in different ways. So I think it's a really good test and a red flag that if an advisor that you're trying to work with on the wealth management or brokerage side is giving you one rate of return, then that's a signal about their integrity more than anything else. But what we try to do because I think clients should know is what we've done is we've taken a representative sample of our client's actual portfolios. Of course, we remove all the names and we go through, let's say, 10 or 15 of these portfolios over time to show them how that rate of return has evolved.

When we go through that, they say, OK, I'm starting to understand a bit better. This client made a 9% rate of return and they had 60% equities last year. This client had a 40% equity allocation and they made 7% last year. They can start to see the elements of a portfolio that drive that return.

Is there a range that's manifested pretty consistently when you do that sample size?

When we talk about that range 6% to 8% after all costs. When I think about the time period to measure that, I always say it's over a market cycle. And what is a market cycle mean? It means the bottom of a bear market to the top of a bull market. So when you look at your rates of return at the top of a bull market, those should be within that range, give or take exceptional circumstances with a particular client. If a client says, I don't want to have equity exposure, I want to have bond exposure, then clearly you have to be comparing the right things. You can't compare apples and oranges.

Are there other ways to measure value or success rather than the rate of return or in addition to it?

The other part around value is taxes and planning. You've been through many annual reviews. We actually don't outline how much taxes we saved because we've invested or given you different advice that isn't quantified in the number. I can think of many, many what I call special moments with clients where it really an opportunity comes up once and they need advice around that. Whether that's an illness they might have, whether it's a breakdown of marriage, whether it's the opportunity to buy a cottage property and they need help financing, whether that's the sale of a business that creates a lot of value in our conversations that aren't measured. And those conversations sometimes drive value that swamps the money we make in a client's portfolio year to year.

I think the second part is, who do I talk to when things change? Back in 2009, at the end of the great financial crisis bear market, at that point, governments enacted quantitative easing which meant they bought bonds, they drove interest rates down to artificially low levels, they were involved in the market much more than they ever were before, and they did that to drive asset price returns. They did that because they needed to create stronger balance sheets for the banks and people in general. And what that did is it created 11 to 12 years of passive investments outperforming active investment managers. And it created a generation of investors that thought passively putting money into an index in itself would always be the best thing to do.

And then 2020 hit. And what was interesting about 2020 is the market dropped in March of 2020, rallied back very quickly. It didn't give people the opportunity to feel the real pain of a change in market conditions because what did governments and central banks do? They doubled and tripled down on the same policies. Now that response caused massive inflation, the very rapid rise in interest rates, almost historical rise in interest rates in 2022, and obviously the corresponding bad markets that occurred in 2022, which were coming out of. But the takeaway there is that it made people realize, OK, it's not as easy as people think.

And that's never really measured in these conversations and people don't think about it. But I remember quite viscerally checking the Twitter handles on a Robo-Advisor. During that time, I saw their clients absolutely lose it on Twitter because they couldn't get in touch with anybody.

Do you have anything to say or I can almost guess what you'd say about people who want to be self-directed with their portfolios because they believe it's their money and that they can achieve a higher rate of return by chasing change?

I think that the do it yourself for investor has actually calmed down quite a bit in the last two to three years. After 2022, when things became very, very difficult, I think that people realized for the first time investing isn't easy. Investing is a learned skill. Everything that's thrown at us daily is a very unique event. Russia invading the Ukraine, war in the Middle East with Hamas and Israel, inflation we haven't seen in 40 years, yawning deficits in Canada and the United States. These are things that we are only seeing for the first time. And if humans were really good at just ignoring the noise and the fear, then I think doing it yourself and investing for very, very long periods of time is possible to do quite well. I believe that, but my observation is that most human brains are not wired that way.

We are governed by our amygdala, the fight or flight part of the brain. Even with people that I've had the same conversation with, I've seen them go from risk loving to being very fearful just because of what happens with the price of a particular asset. So do I think in people trying to do things themselves there could be a good outcome? It's possible, but I think the probability is low because of the way they're made up.

I think also that what you're describing is what you do as a living full time is not something that someone can dabble in and expect the same level of success.

I was managing my hedge fund and it was late 2000s. I remember a statistic that came up on CNBC and it showed that for 10 years investors in the S&P made no money. And today, if you actually ask people what they think about the S&P 500, they think it always makes money. So imagine and I was speaking to people at this period of time that had their life savings in stocks. They said, how are we ever going to get this back because we're at our retirement age? And it never occurred to them that perhaps they should have shifted their asset mix or that this could actually happen. So things that happen in the markets are multi-decade things, and you have to have some background on that.

You know, for a lot of people, 6% doesn't sound like a lot or enough. It may sound conservative to them.

Well, it makes me think about why everyone was piling into GICs in the last two years. So if 6% is conservative and really easy, why would you put your money away for five years at 5% in the most tax inefficient investment you can have?

You're referring to a GICs.

GIC. And the reason was people hadn't seen GIC rates at 5% for so long, and they just came out of off 2022 where their portfolios were down. And they said you know what, I didn't make money last year, but I can guarantee myself making 5% this year. Why don't I put my money there? And they did that. And that's a perfect example of the amygdala at work. And what happened only a year later, the equity markets recovered and they were locked into GICs. So I don't think people have a very good sense of how the markets can change. If markets are up 20%, they're going to think 10% is bad. If markets are down 20%, they're going to think 5% is good.

So if I say I want to make 14%, what do you say to me?

I would say there might be an advisor out there for you that would try to target that rate of return annually, but it wouldn't be us. Now, why I say that is because if we put you in 100% stock portfolio, and we know that the historical return long-term is 10%, how can we credibly suggest that on average, you're going to make 400 basis points more than that? It would require us trading in the best stocks and probably using leverage for your account. That's not realistic, it's not our business model, it's not what? And it's not fundamentally what you need as a client of ours.

You need us to make a rate of return that helps you achieve your financial plan. Yes, the rate of return is important and trying to do well, but it's what is the rate of return staff needs or a client needs to make sure their plan is viable? That's the number they should be focused on.

What do you want people to remember most of all out of our chat today?

I think you have to think about the conversation about returns multidimensionally. You need to think about it as it relates to risk, as it relates to your plan, as it relates to your psychology, as it relates to your tolerance for the ups and downs of the market.

What are we going to talk about next time?

I think talking about advisors. Do people need to have around them to be successful in the next 5 or 10 years and what that process looks like.

Thanks, Mike.

Thank you.

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