When sharing investment results with a client, many financial advisors imitate what they see on financial websites and fund reports, citing year-to-date returns or other routine performance markers.
But advisors shouldn't mindlessly mimic the reports. Clearly explaining performance data is critical to gaining and keeping their clients' trust in their process.
One data point to consider: rolling returns, which are average, annualized returns for a particular time frame.
Many advisors, however, don't consider this data point when reporting returns. Instead, their default route is to parrot those outside sources, using a format for returns based on year to date, quarter to date, and periods of one, three and five years, and "since inception."
There is nothing inherently wrong with using these metrics, but it is far more instructive to use rolling returns as well.
Here's what advisors should know about rolling return analysis – and how to reveal this illustrative data point to clients.
The Advantage of Using Rolling Returns
Rolling returns allow an advisor and clients to view past performance as an ongoing series of return periods, where the goal is to "win" as many of those periods as necessary to allow clients to reach their goals.
By doing so, rolling returns also present a more realistic view of how a client is doing. It is not merely a sound bite.
For example, using rolling returns could involve showing a client her investment performance for July 2020 through July 2021. Next, an advisor would present returns for June 2020 through June 2021, May 2020 through May 2021 and so on. With the right investment reporting software (or an Excel sheet and access to monthly return data), you can quickly evaluate and present rolling returns.
Advisors who don't go beyond explaining so-called trailing returns, not including rolling returns, are taking a massive risk. That is because they are only giving clients a fraction of the story. And when you only tell them part of the performance story, you are counting on them understanding the totality of their results based on that tiny snapshot.
Think about it this way: You have been advising them and investing their wealth for years. And when you have their full attention, you do what amounts to cherry-picking based on someone else's idea of what is important. Why put yourself in a position where you don't have sufficient information to tell the complete story?
How Returns Can Be Manipulated
Don't let competitors use creative return calculations to lure away your clients. If you were to show your clients the 10-year annualized returns of an investment from different start and end dates, some periods would have better results than others.
For example, if you look at the annualized return for the S&P 500 index for the 10 years ended Dec. 31, 2020, the result is about 14% per year, thanks to massive Federal Reserve stimulus and an implied put option protecting stock prices and certain areas of the credit bond market. If you look at the 10-year period through the end of 2016, the return is only 7% per year. And from the end of February 1999 to February 2009, the S&P lost 3.4%.
This sampling of the S&P 500's performance shows how easily the math of past results can be manipulated. You don't want your clients and prospects to be fooled by a competitor's math, and you don't want to be the one accidentally doing the tricking. That's why understanding rolling returns is so important: a snapshot doesn't tell the whole story. It's like seeing five seconds of a movie and believing you understand what the other two hours are about.]
How to Present Rolling Returns to Clients
Explaining rolling returns involves showing how a client's portfolio performed, but without resorting to showing them a snapshot.
One way to communicate rolling returns is to liken performance to a free-throw percentage by a star basketball player who's in the 90% range. For example, let's say your clients have a 6% annualized return objective. You can show them their three-year annualized returns over many 36-month periods (with different start and end dates), then display for them their statistics using that collection of three-year data.
The presentation might sound something like this: "You have been a client of ours for exactly seven years. That means we can analyze 48 different periods of three years (36 months each). We'll start with the first three years you were a client, then add another observation to the analysis each month. I'm happy to report that in 43 of the 48 periods, your annualized three-year return was at least 6%. So, 90% of the time, if you give us three years to reach your return target, we succeed. For perspective, your benchmark only achieved that 6% annualized return 40% of the time. So, we are doing well."
You can add more features to this presentation, such as results from other time periods. For instance, if you are a user of Riskalyze (or one of its peers) to measure risk in terms of six-month probabilities, you can present actual six-month returns, and the frequency of success versus whatever benchmarks you and the client agree are appropriate. It may also be helpful to analyze periods that include the 20% S&P 500 drop in late 2018, plus the five-week, 33% drop in that index in early 2020.
Avoid the Classic Performance Discussion Trap
The reason to improve your explanation of investment performance is to make the client relationship more "sticky" and facilitate discussions that add value for your clients.
Don't fall into the trap of displaying to your clients that you are not keeping up when the market is soaring. Why back yourself into that corner?
Rolling-return analysis is one tool for turning any investment performance review into an enlightening experience for your clients. It might just make them more likely to refer you as well.