A Better Way To Measure Success

In 1928, while working on his WWI epic, Hell’s Angles, director Howard Hughes faced an issue. While filming the dramatic dogfight scene, he realized the drama, excitement, and thrill of the airborne fight wasn’t being translated onto the big screen. The issue was that the sunny sky of Southern California was missing something: clouds. Without clouds there wasn’t a reference point in the background to provide the audience with a sense of the danger and high speeds.

Months had passed without the clouds he needed, and no matter how hard Hughes hoped or wished or prayed, the clouds wouldn’t come. He was trying to control the weather, something that’s surely uncontrollable.

Hughes pivoted, from focusing on the weather to instead focusing on variables he could control. He hired a meteorologist to help him find clouds. He expanded his team of planes and pilots to incredible numbers. He rigged as many cameras as he could on his planes to get the most footage possible. Everyday it was costing him a lot of money. But it was all in an effort to ensure that when the clouds appeared, and he had his chance to finish his masterpiece, he wasn't going to miss it. He was doing what he could to ensure he was successful, and when he finally got his chance, with clouds over Northern California, he nailed it. The dogfight scene is still considered one of a kind, and a cinematic triumph.

Hughes found the success he was looking for because he pivoted from focusing on what he couldn’t control: the weather, to what he could control: being ready when the clouds appeared. For investors, there’s an important lesson here when it comes to having success: spend more time focusing on what we can control, and less time on what we can't.

We all want great returns, but the market is something we can't control (if we could, we’d all double our money every year). The good news, is there are variables within our control that can lead us to success. Investing success comes down to doing the little things right, for a very long time. By focusing on the process instead of the outcome, we can get life changing results with expected, not exceptional, returns.

Key Takeaways:

• Annual returns don't accurately reflect our success as investors because they are too inconsistent, variable, and don't reflect our effort.
• The best way to gauge our success as investors, is to compare the effort we're putting in, to the effort that's required to meet our goals.
• We should instead focus our efforts on variables that are well within our control, that we know lead to success over the long term.

Why Returns Alone Fail To Measure Success

Investors often use annual returns to measure their success. The idea being, the higher your return, the more successful you are.

But investment returns are really only relevant to the year they occurred in. If we look at historical returns of the S&P 500, the difference between best and worst year is nearly 100%. Which means that what could be considered a good return in one year, isn't guaranteed to be considered a good return in another.

In 2022, when the S&P was down -19.4%, a return of -10.0% could have been a good return. But in 2023, when the S&P was up 24.2%, a -10.0% return might have made you the worst investor that year. It's a great example of how quickly markets can change. Highlighting that change, below is a chart ranking key indices in performance. By looking at colours, it's clear to see that rarely does anything stay the same.

The question also arises of how we view a year when markets are down? If we are solely looking at returns as our measure of success, in a year like 2022 when everyone had a negative return, should that be considered a waste of a year? We can do everything right, and still end up with a negative return in some years. That's a reality of being an investor.

As an example, let's say in 2022 and 2023, someone contributed $100 towards their investments every week. The exact same effort in each year. The only difference, is that in 2022 their portfolio had a negative return, while in 2023 they had a positive return. Would you say that one year was more successful than the other? If you think yes, what could have been done differently?

The other issue with using returns as the measure, is people can be after different things. An investor with an aggressive mindset and a long time horizon might prioritize growth, whereas an investor who is enjoying their retirement should prioritize preservation. In most years, the growth investor should come away with a higher return, but that doesn't mean he's more successful than an investor who earns a lower return.

Because of the inconsistency and variety of outcomes, on their own, annual returns might be the worst way to gauge success. They don't reflect the effort we put into our investments in a given year, and they don't capture where we are relative to where we want to be. By understanding how investing works, we know that returns are an outcome of a successful process. We can't control the returns we get, but we can control variables that influence the outcome we're working towards. We can't control the markets, but we can control how we participate in them.

A Better Way To Measure Success

Investing is the best way to take us from where we are today, to where we want to be in the long term. Done properly, investing over a lifetime can create passive growth that results in decades of income during our retirement. It's like earning income for a job that you don't do, but your money works instead.

With that in mind, the best way to measure our investing success, is to define what our long term goals are, and compare the effort that we are currently putting in, to the effort that is required in order to meet our goals. By understanding what we need to do in order to get to where we want to be, we can clearly see if we're on track, even in a year with a negative return.

Let's looks at a very simple example, someone is 30 years old, currently contribute $400/month, and their goal is to retire at age 65 with $1,000,000 of investments. If we assume a rate of 7%, they would need to contribute about $550/month over the next 35 years to meet that goal. There would likely be other financial factors like: staying out of debt, making mortgage payments, paying off loans, and other short term goals. But we can see how we can measure their effort, to the effort required to meet their goal.

Just like any plan: life happens, things change, and we have to adjust. Financial plans should be as accurate as possible with the information you have at the time, but over time that information will change and plans have to be adjusted. That should be expected. Our jobs, income, family situation, home, cash flow, all change over time. It could be something small or something big that requires our plans to adjust. But those adjustments go both ways, something that is perceived to be a bad adjustment could likely get corrected by a good adjustment in the future.

A comforting fact about financial plans is they should never be designed with getting the highest returns each and every year. When we look at long term averages of past performance, the number we get takes everything into account. The highs, the lows, and everything in between. And it shows us that instead of chasing returns and exposing ourselves to additional risk, if we're just able to get something similar to the historical average performance of our portfolio, we'll be more than fine.

What We Can Control That Leads To Success

Just like Howard Hughes couldn't control the weather, we can't control the markets. Markets naturally flow up and down, but over time the ups heavily outweighs the downs, and we see growth at exponential rates. However there are things that are well within our control that help influence our success through markets.

Instead of chasing returns hoping that something will work out and we will get the return we are looking for, we can set ourself up for success by ensuring the things that lead to success are optimized. Taking the guesswork out of our approach by relying on nearly a century of investing data. Investing success is all about doing the little things right, for a long enough time, we know that leads to success.

How We Invest

How we invest can cover a lot of different things, but there's two main things that are really important: asset allocation and diversification.

Asset allocation refers to the mix of stocks and bonds within your portfolio, you can think of it as like the recipe. Stocks provide more growth potential, but are also more volatile. Bonds offer less growth potential, but have historically been more stable. Your ideal mix will be based on things like your: goals, risk tolerance, and time horizon (things unique to all of us).

The recipe of our portfolios matter greatly because we know that stocks and bonds offer different advantages. As long as you can handle the volatility, a stock heavy portfolio offers the most advantage over the long term. The further out from a goal, and the more secure the funds are in the account, the more aggressively you can invest. In the opposite direction, a bond heavy portfolio offers the most stability as is best for approaching goals, or situations when you rely on the funds consistently.

With asset allocation, the way that you invest is more important than the returns you get. Someone in retirement with a tight budget shouldn't take a gamble in a high risk investment. The potential loss would be devastating. Over our lifetime, we naturally shift from a growth mindset (during our working, accumulating years), into a preserve mindset (during our retirement, decumulating years). When people have different goals, comparing returns is like comparing apples to snowmobiles, it makes absolutely no sense.

The other important part to how we invest is diversification, the idea of not putting all of your eggs in one basket. Within each asset class: stocks and bonds, it's important to ensure that we're invested in many different companies, from many different industries, from many different countries, all over the world. That way if a single company, industry, or country goes through some financial turbulence, it represents a very small piece of our portfolios pie.

Diversification also helps provide our portfolio with longevity. The volatility we experience in a diversified portfolio is short term, we know that it will bounce back. If a company fails, there are literally thousands of others to pick up its slack. Remember that we invest in companies that we use each and every day, so in order for a globally diversified portfolio to drop to $0, we'd be living in a world where no one has jobs, money has lost any meaning, and there would certainly be bigger things to be concerned about.

David Swensen, the renowned chief investment officer of Yale University's Endowment Fund, attributed 90% of a portfolios performance to diversified asset allocation. Which shows that above all else, being properly invested for your goals, plays the biggest impact in how your portfolio performs.

We can look to the past to see how different asset allocations have performed and give ourselves an idea of what we should realistically expect moving forward. We can't control the markets, but we can control how we participate in them, and therefore influence our long term returns. By ensuring we are in an appropriate portfolio to our goals, how we invest is a controlled measure we can use to gauge our success, even in a down year.

Contributions > Returns

In the beginning, the main growth we see in our investment accounts is from contributions, not returns. But the longer we invest for, the more that relationship balances out, until returns fuel the majority of the growth we see. Over time, it would look something like this:

After we're set up to invest properly, the next priority should be to fund our account with money that can work for us. Our contributions not only provide the most account growth early on, but it also increases the amount of money that we have participating in the markets. A 20% return in any year is a fantastic thing, but it's a lot nicer when that return is over $100,000 ($20,000) than $10,000 ($2,000).

Contributions are an effort we can measure, no matter what happens in the markets. If we have a contribution goal, we can strive to hit it. Even in a year when markets are down. Contribution goals are something that we can look at the measure our success, because it's something within our control.

Time In The Market

Warren Buffett's secret to creating wealth, above all else, is time. Success is not about timing the market, it's about time in the market. Below is a chart of Buffett's net worth by age, and a separate chart showing how regular contributions could naturally grow.

They look almost identical. It's unlikely that we'll ever see Buffett-like net worths, but we can certainly all see Buffett-like growth. And we don't have to do anything clever, all we have to do is put our money in a position where it can work for us, and it'll do the rest. Showing that the best thing that we can do for our investments, is to let them to their thing, for as long as we possibly can. The longer our money can be invested, the larger and larger the difference it can make for us.

The other advantage with time, is the longer we invest for, the more certain our expectations can become.

In the short term, outcomes have a wide range, and although they lean far more positive than negative, the shorter the duration the larger the chance of a negative outcome. That's why stock heavy is better long term, and bond heavy portfolios are better for shorter term goals. But in both cases, over a long enough period of time, we see the chance of a negative balance dwindle down to 0% and stay there. We also see the spread narrow, as our range of historical outcomes narrow. Every time period, the worst outcome becomes better and better.

By allowing our investments to work for us, we are increasing our chance of success, and there are measurable actions we can take to ensure they can be left alone. By building an emergency fund, or having separate accounts for short term goals, we can reduce our short term need on our long term investments. Leaving our investments invested, is a measurable control that can lead to success.

Behaviour

With investing, just like many things in life, there are a lot of things that matter, and a lot of things that don't. When we are able to differentiate between the two, it becomes a game changer.

People find success in the things that they do when those things are aligned with their values and their beliefs. We want to care about and be invested in the decisions that we make on a daily basis. It can be tough to think about our future self in retirement 40 years from now. But becoming familiar with who we want to be, is incredibly important for our long term success.

When we have a clearer idea of who we want to be and how we want our future to look, we can more easily make decisions that prioritize our future self over our current self. It allows us to think more objectively to find a better balance between happiness today and happiness in the future, even if it's 40 years away.

In the short term, as investors we are pulled in the direction of a lot of bad news. Negative news headlines sell, so they are full of reasons why you shouldn't invest, not reasons why you should. We also see headlines of people getting 'rich' on crypto or meme stocks. It can create a sense in us that we should be doing more, that there's this great rush of wealth that we are completely missing out on. The goal is to be able to block out the noise that doesn't matter (which is most, if not all of it), to not get stressed, anxious or worried. The way we do that, is by having a concrete plan that we can lean on, that is based on long term decision making that we believe in.

Our behaviour should reflect our values, our beliefs, and what matters most to us. If you want something to change, don't just hope for it, do things everyday that supports the change you want to see. If you want to become a better investor, don't wish for it, do things everyday that prove you are a better investor. By understanding what matters most to us, we can make better decisions that prioritize what we really want, over short term instant gratification. By making better long term decisions, we can use that as a measure of our success as investors.

Redefining Investor Success

The best way to gauge our success as investors, is to compare the effort that we are currently putting in, to the effort that is required in order to meet our goals.

That effort is captured by the normal things we do each and every day: make contributions towards our investments, optimize our investments, let our investments work for us, improving our financial situation, prioritize our future self by setting goals, and behaving in a way that prioritizes what we really want. They're actions that we can measure, regardless of a years return.

Like Hughes, we can't control the weather, but there are things we can control: how we react, what we wear, and what activities we do, all in an effort to make the best of the weather we are given. Similarly, we can't control the markets, but we know with nearly a century of information that there are variables that we can control, that lead to better results. Our success shouldn't be measured by the annual return we've achieved over the past 12 months, but by our commitment to those things within our control that lead to the results we're looking for.

Even if down years, we can use the following to gauge our success as investors:

✅ I am on track to meet my goals
✅ I have confidence in my plan and the process
✅ I am less stressed about what happens daily in markets
✅ I am working towards my goals that are within my comfort level
✅ I spend more time doing what I love, and less time worrying about my money

If you can answer 'yes' to all or most of those, then I'd say you're on the right track.

Keep doing things your future self will thank you for.