I often ask prospects what levels of return they want. This is a simple test to see if they have achievable expectations.
Usually, their answers are in the 5%-to-8% range. Sometimes they respond with levels greater than 20%. Other people say, “I have no idea.”
When faced with the latter two scenarios, I don’t lecture them about historical returns or risk tolerance. Instead, I alter their perceptions. I ask, “If you gave me all your money today and in 10 years you had double that amount, would you be happy?” Most people say yes.
For those who don’t, I move the bar and say, “Okay, how about 9 years,” then 8, and so on. Sometimes I suggest 11-, 12- and 13-year doubling periods. Once I’ve discovered their comfort points, I tell them they just told me they would be happy with returns of about 7.2% (which I calculated using the Rule of 72). So, if a return in the mid-single digits is sufficient, why take on exponentially more risk to shoot for 20%? From there we move to conversations about what is doable in the current market reality.
What did this exercise accomplish? Besides talking prospects down from an attempt to bet the farm, it exposed the flaw in their perceptions. People don’t think in exponential terms, and that often leads to a misconception of what is necessary to achieve a set goal. By changing the concept for return from percentages to dollars, it helps people to grasp a more realistic scenario.
No accounting for time
A more recent example of flawed perception has resulted from my company’s statements.
These statements list clients’ percentage and dollar returns over the last five years and the period prior, and their total dollar returns since inception.
Since 2008, most clients have been satisfied with the annual return numbers. But I often find just as many are disappointed when I tell them how much of their account is profit versus principal. The most common response is, “How come my account is only one-third profit? It’s been 10 years. Didn’t we talk about doubling my money in that time?”
Find out how I answer them by going to page 2.