How to Evaluate Your Stock Market Returns

How to Evaluate Your Stock Market Returns As An Individual Investor

‍Every now and then there is a story about an ‘astute’ stock market picker who struck gold ‘overnight’. The story of these individual investors (also called retail investors) may even be picked up by local news rooms and credible online publications. Some of these astute / ‘lucky’ investors – which ever you prefer to call them - have gone on to leverage their successes into cult followings on some online media platforms.

If you are looking for someone to follow to get stock picking ideas, the most important thing to do is to first look inward and consider your personal investment goals. I am not suggesting that you should not follow your preferred seasoned stock pickers out there, but unless you have a seat at their table or walk in their counsel, you will not always know their planned holding period, their ability to weather financial setbacks, and the indicators that they are watching to see if the stock has reached its peak value. If they are big investors, you are always going to be trailing their decisions, as by the time you find out what they are doing through their SEC13F filing, a lot (like price and other fundamentals) may have changed about the stocks they have picked.

Starting with your own investment goals is a very good way of attaining some level of rationality in your investments. Otherwise, you will always be jumping from one investment advice / trend to another. To help you evaluate whether you are doing all too bad / good by yourself…

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Some Few Suggestions

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1. Know What Your Bank Pays in Savings Accounts and other near-liquid money market investments – If you left your money in a savings account, how much would be the return on your investment? Bear in mind that an investment with a 0% return is not necessarily the worst investment option. In fact, it may be a good investment if you plan to use your money for something else in the short-term (under 1 year), or when you expect those savings to be called upon anytime. There are plenty of investments in that time horizon where you can do less than 0% in investment returns…on the stock market. Yes, it is possible to put $100K in a stock today, and tomorrow, it is worth only $90K. Now, if you had all the time in the world, you could do worse (if the underlying business whose stock you are invested in files for bankruptcy, and there is nothing left for ordinary stockholders), or much better (if over time, the stock price recovers and keeps marching north)!

If you have a sizeable amount that your bank will take for a Certificate of Deposit (CD), then you can talk to your account relationship manager, and see your options. You can also consult credible sites for the current CD rate. Say your bank will pay you 4% per annum on a CD, and 0% if you left your money in a savings account, and you are sure you will not need to use that money in the next year, 2 years, 5 years…then you can consider the 4% per annum rate on a CD as the minimum return you will accept for your savings investment. If you think you can do better than 4% by investing on the stock market, then you can do that with the peace of knowing that anything above 4% would be acceptable for you. Some other people may not accept that rate of return based on their own circumstances, but you my friend, should be grateful for anything above the CD rate the money market was going to pay you.

2. Beware of Inflation – Whether you choose to leave your money in a savings account, earning 0% or put it in a CD that pays, say 4% per annum, you should consider the effects of inflation on your money. Generally, if the inflation is, say, 6% per year, an investment that gives you a 4% return per year will leave you 2% worse off in inflation-adjusted terms in that year. It is prudent to always base your return on investment on the inflation rate, while bearing in mind that the rate is a weighted average and may not take into consideration the purpose of your savings. For instance, if you wanted to buy a new car, and car prices are firming at a rate of 10% each year, your rate of inflation for your particular preferred purchase is 10%. You may need an investment that keeps pace with the asset you are saving to buy. If you are saving for education, the same principle applies. In that regard, you should think of the national inflation, and your own, individual inflation (the asset you are saving for) as determining your personal minimum required rate of return.  

3. Other Attainable Investments

‍Every individual stock investor has an area / sector where they have a specialist skill / expertise in, and can invest their money in that area, away from the stock market, with great competency and more assured returns. As a serial entrepreneur, I am always building startups. If I had $100K, I would have to consider if this money will earn a better return on the stock market, my startup, or invested in a colleague’s startup. Likewise, someone seasoned in real estate and has access to funding for short term and long-term loans can lever their savings and undertake large scale real estate developments, with investment returns they can estimate with more certainty. Similarly, a used car salesman may also consider investing in used car inventory. We all have areas where we have superior information and will happily invest in those areas with less uncertainty of returns. In that case, the opportunity cost of investing in the stock market is the other ‘surer thing’ forgone. Say, an investor has $500K to put in a 2 to 5-year real estate investment project where, due to their years of experience in the sector, they know they can estimate the returns with increased certainty, then it may be prudent to invest in the real estate project. Sometimes, people who make it on the stock market may diversify a portion of their investments into areas of their specialty. A small business operator may choose to withdraw their stock market gains and plough the returns into opening other locations for their small profitable small business.

In situations like these, the investor’s minimum required return on investment is the return they know they will get if they put the money into an endeavor of their competency. A used car dealer who knows they can 3x the capital at hand buying and selling cars, will not put their money in the stock market if they are unsure they will make the same return, all things considered. In that regard, when making an investment decision, 300% is the opportunity cost. In the absence of other investment options offering better returns, this opportunity cost may be equal to the investor's minimum required rate of return.

When picking stocks as an individual investor, if your opportunity cost is say 10% per annum, and you buy a stock that eventually returns 30% per annum, even if you know that the Jones next door had a 300% return on their stock portfolio, you should be grateful for your 30% return as that is still better than the options you had at the time of making your investment decision. Trying to keep up with the Jones can only breed greed, unhappiness, poor investment decisions or worse (all 3 at the same time).

Together with this, retail investors should consider the famous advice from legendary investors Warren Buffett and Charlie Munger, that many stock market investors are better off buying index funds, like the S&P 500, and leaving their money there. For this reason, many professional investment managers are benchmarked against index funds first, before competitors. If an investment team does better than the index funds (and there are many niche index funds out there) then it means that they have done better than the average overall market return (or its sub-niches depending on the niche index fund being used as the benchmark). In the absence of any other measure, the general market index funds would do. In the same vein, even if you know of someone who has done vastly better than you, if as an individual investor, your returns are better than the S&P 500, you have cause to celebrate because you have done better than the average market return.

Realize how after savings, one can compare with CDs (or other money market products), the adjust for Inflation, and then consider the opportunity cost of expected returns from available, attainable alternative investment options. All these options may keep raising the minimum required rate of return an individual stock picker would consider acceptable and sufficient for their risk tolerance.

4. What Is Your Long-Term?

A week can be a very long time on the stock market.

Like many people, we all like to take advice from legendary investors to the extent that we forget to ask ourselves a very pertinent question – what is my long-term? A billionaire stock market investor can weather personal financial setbacks better than many individual stock investors. Before you go chasing the stock picks of a billionaire, consider that they can wait out events 5 years into the future, and withstand temporary market downturns along the way. If you will throw in the towel at year 2, because it’s time to liquidate your investments and fund your child’s education, or because the futuristic event that you anticipated would happen (needing you to call on your savings) has happened, then you may need to consider stocks within your own risk profile. Many people want to say ‘if you had invested $10K in Apple / Microsoft / Amazon / Google and the other usual suspects at IPO, you would be x-times a millionaire'. Few forget that many people who invested in these companies at inception (IPO) bailed before today, out of necessity – they simply had living expenses that required them to liquidate their holdings. Such is life.

Before you go out latching onto trendy stock investment maneuvers out there, and everyone who says, ‘Why you should by Stock X’, you need to consider that your individual investment goals matter more than anything else, and since you are a very unique individual – not many investment strategies will fit into your personal investment horizon. And if, all things considered, you could do better than inflation, do not forget to pat yourself on the back, even as you grumble at your inability to better the Jones next door.
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Happy investing!

The above article is not investment advice at all – please turn to your professional investment managers for that. Do ask them if they do better than inflation, year-over-year.

About the Author:

Tav is a Boston-area entrepreneur, investor, and optimist

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