Factors That Could Influence Your Investment’s Performance
Setting performance expectations from your portfolio returns is an important step towards attaining financial success. Your portfolio performance expectations lays the foundation for you to build a wealth corpus on in the long term. Knowing how much an investment is likely to fetch you in returns also helps to figure out if it is indeed the right investment for you or, if you must switch it for something more conducive to your risk profile.
While keeping realistic expectations is essential, there are several factors that can cause your expectations to derail. Being aware of the elements – ones within our control and ones outside of our purview (external factors) – that may influence the performance of your investments help set the right tone for expectations of returns. Here are some such factors:
4 internal factors that influence investment performance
1. The choice of financial Instruments
Your choice of investment instrument will largely depend on your risk appetite, and therefore the impact it has on your investment’s performance. As you know, the more risk you take, the more potential there is for higher returns. For instance, the risk-averse may choose bonds over stocks. However, expecting your bonds to return as much as stock investments within a specific time period is unrealistic. Meanwhile, mutual funds may give you the edge of stock investments while protecting your income to some extent like a fixed income product does, and your returns may be midway between bonds and stocks. Thus, a prudent and well-calculated choice is essential when picking products to build your portfolio.
2. Time horizon
The time horizon for your financial goals will allow you to plan for your investments in the right manner. If you are looking to raise some money for a short-term goal, such as a home appliance purchase, you can invest in short-term capital assets such as stocks. However, if you are saving for a long-term goal, such as retirement, you may consider a mix of products that return better on the long-term (A part in equity, a part in fixed income and another part in alternate asset classes). It is unfair to expect one asset class to perform at par with another within the same time frame. Equity may be very volatile in the short-term, but may perform better longer term. Your expectations of returns need to be in sync with your understanding of the performance of your chosen investment within a given timeline. The time horizon of your investment is essential to note as it affects how your returns are taxed (short-term capital gains tax and long-term capital gains tax), and hence your overall earnings.
3. The amount of the investment
The more money you invest, the more you can earn over time. The right balance between saving, spending, and investing is in your hands. This combination will alter how your financial standing grows in the future. Therefore, you must analyse every aspect before making any decisions. Having said that, your expectation of your investment portfolio’s performance should be in sync with the amount of money you invest. For example, if you invest $5000, it is unlikely to double within the year, irrespective of what investment avenue you choose. Equity, which is an asset class known to provide maximum profit (and losses during the downturns), returns in the range of 12-15% annually. The amount of money you invest influences the returns, and therefore, it is important to set your expectations for the investments performance accordingly.
4. The cost to acquire the investment
Cost of investment refers to the money you need to spend in order to make an investment, such as advisor fees, broker commissions, transaction charges, annual maintenance charges, taxes, etc. Though it is often ignored as just a drop in the bucket, it does influence the total earnings from your investment. Large-ticket investments will have a sizable cost of investment, which is in reality, an expenditure. So, if you budget to invest $50,000, check with your financial advisor to know what the actual amount being put into the financial product is so that you may gauge accordingly how your investment may perform.
4 external factors that influence investment performance
1. Federal actions
Federal rules and regulations can determine how your money operates after it has been invested. Taxation rules, withdrawal and contribution limits, etc., although not in your control, will play a vital role in the outcome. When the Fed increases liquidity in the market in an attempt to revive the economy (like it has done after every recession) it affects the value of the dollar, the interest rate of investments, the stock markets, bond prices, and even real estate costs, in some cases. Likewise, when the Fed is concerned about inflation, it may choose to tighten monetary policy, leading to a liquidity scrunch – i.e., the central bank raises interest rates and deposit ratios to make credit less easily available. This makes investments costlier, affecting the returns you can get within particular time horizons. While these factors are not in our control, it is necessary to watch out for any such changes and understand the time value of money before investing, and also to set expectations for your investments performance accordingly.
Check out our article on the decision framework for holding U.S Government Bonds for an example of how much Fed policy and interest rates can affect the returns on a product. Click here to read Should You Hold Or Sell Your Long-Term U.S. Government Bonds?
2. Supply and demand
The supply and demand graph for investment products can impact prices and change the course of your expected returns by influencing how and when you buy or sell your investments, be it equities, commodities, bonds, real estate or any other investment avenue. For example, you may have invested in the shares of a company hoping to stay invested for 5 or 10 years, pegging your expectations according to your understanding of the company’s core strengths. However, there is always a risk that things may not go as expected – a drop in price that is below your risk level might influence your decision to short-sell your shares. Similarly, when supply is less, demand for commodities increase and prices go up, and when supply is more, prices come down.
3. Market volatility
Perhaps the most commonly used phrase in the world of investing – ‘market volatility’ is beyond any investor’s control. The market works in a cyclic manner, and a period of boon is usually followed by a period of lull. However, the functions of the market can really never be predicted in advance. Volatility may impact the returns of your short term investments, and it is necessary to factor it in when setting the expectations of your investments performance.
4. Geopolitical risks
The relations between different countries and economies can impact investments in ways that one cannot imagine, given the interconnectedness of our world. What happens when the US blocks China or goes to war in the Middle East may affect market sentiments, thereby indirectly impacting the performance of investments.
To sum it up
Money begets money, but how much money you can make from investing depends on the decisions you make as an investor. There are various elements and factors that influence the performance of your investment portfolio, and while some are in your control, some are outside of your reach. Knowing about these factors will help you hedge the risks and maximize your returns. Additionally, making informed decisions will also lead you to setting the right expectations from your investment’s performance, which goes a long way in determining the success of your investment plan.
If you need to get in touch with a financial advisor to understand how to calculate your investment performance expectations, or create a portfolio which can give you expected results, get in touch with Paladin Registry. Paladin Registry’s free search tool matches you with the best financial advisors in your community who are fiduciaries and are equipped to help you accumulate wealth through investing.
To learn more about the author William Hayslett view his short bio.
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