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How Much Will Your Investments Earn? 7 Key Factors

July 5th, 2023 | 4 min. read

By Jacob Schroeder

Adviser explaining investment performance

As you strive to build and grow your portfolio, understanding the key factors that impact investment returns is crucial.

For clients at Advance Capital Management, we provide professionally managed portfolios that seek to balance maximizing returns and mitigating risk based on their goals.

While various elements influence investment performance, focusing on factors within an investor’s control is essential. This article sheds light on the seven key factors that can significantly influence portfolio returns, empowering you to make informed investing decisions.

This article covers the following factors that impact your return:

  1. Asset allocation
  2. Diversification
  3. Investment selection
  4. Cost management
  5. Rebalancing
  6. Market and economic conditions
  7. Your decisions, risk tolerance and time horizon

1. Asset Allocation

Let’s start with asset allocation, or the strategic portion of investments across different asset classes such as stocks, bonds, real estate, and cash. It plays a vital role in determining portfolio returns.

In fact, studies have consistently shown that asset allocation is a primary driver of long-term investment performance. One study found that asset allocation is the primary determinant of portfolio returns and can explain a significant portion of the variability in returns. The study concluded that strategic asset allocation decisions accounted for approximately 90% of the variability in long-term portfolio returns.

Typically, riskier asset classes, such as stocks, have the potential for higher returns but come with higher volatility. On the other hand, less risky assets, like bonds or cash, generally offer lower potential returns but provide stability and act as a hedge against market downturns.

By selecting a suitable asset allocation strategy based on risk tolerance, investment goals and time horizon, you can aim to maximize returns while managing risk effectively.

2. Diversification

So, how do you manage risk in your portfolio?

By spreading investments across different asset classes, sectors and geographic regions, you can reduce exposure to any single investment's risk. Diversification helps mitigate the impact of market fluctuations and minimizes the potential for significant losses.

By diversifying, you can also potentially enhance your portfolio returns. A well-diversified portfolio typically combines assets that have a low correlation or move in different directions under various market conditions. This allows you to benefit from the potential gains of different investments while mitigating losses.

Consider a report by Vanguard emphasized that during market declines, diversified portfolios with appropriate asset allocations tend to experience lower losses compared to concentrated portfolios.

3. Investment Selection

Now, let’s dive a little deeper.

By identifying high-quality investments with growth potential, investors increase the likelihood of generating favorable returns.

However, the investment selection process is often difficult for individual investors, as it involves thorough research, analysis of historical performance, evaluation of financial indicators, and consideration of market trends.

Most investors benefit from investing in mutual funds and ETFs, which pool together money from shareholders to build a diversified portfolio of securities. They allow you to diversify without having to purchase and manage individual assets. Therefore, you don’t have to guess which stocks will do well when you own a fund that already holds a wide selection of them.

4. Cost Management

Managing investment costs is often overlooked but can significantly impact portfolio returns. Investment costs can include fees associated with buying or selling securities, expense ratios of mutual funds or exchange-traded funds (ETFs), and advisory fees.

High costs erode investment returns over time. Therefore, you should seek cost-efficient investment options and evaluate the impact of expenses on your portfolio's overall return.

5. Rebalancing

Rebalancing involves periodically adjusting the portfolio's asset allocation back to the target percentages. This discipline ensures investments stay aligned with your original risk preferences and goals.

Research has shown that disciplined rebalancing can improve portfolio returns and reduce risk. Rebalancing allows you to sell relatively high-performing assets and buy relatively underperforming assets, thus enabling them to take advantage of market inefficiencies.

6. Market and Economic Conditions

Broader market conditions and economic factors influence portfolio returns. Market volatility, interest rates, inflation, geopolitical events and changes in economic indicators can impact investment returns.

Of course, market and economic conditions are out of your control. However, it’s essential for you to stay informed about market trends, assess the potential impact of economic factors on your investments, and adjust your portfolio accordingly. This may involve rebalancing asset allocations, reallocating investments in response to changing market dynamics, or considering alternative investment strategies during different economic cycles.

How should you invest during a market downturn? Learn how to keepmarketdownturn-1 your investment goals on track with this guide, How to Survive a Market Downturn.

7. Your decisions, risk tolerance and time horizon

The last key factor impacting how much your investments earn is: YOU.

Investor behavior plays a significant role in determining investment returns. Research by DALBAR, a financial market research firm, has consistently shown that individual investors tend to underperform the broader market due to behavioral biases and emotional decision-making. They often succumb to pitfalls such as chasing performance, timing the market, and letting emotions dictate investment decisions. As a result, they tend to buy at market peaks and sell during downturns, leading to suboptimal returns.

Your risk tolerance is another critical factor in investment decision-making. Risk tolerance refers to your ability to withstand fluctuations in the value of your investments and your willingness to take on higher levels of risk. Factors that influence risk tolerance include age, financial situation, investment goals and personal preferences.

When assessing risk, you should also consider your investment horizon—the length of time you plan to hold your investments. Generally, longer investment horizons allow a greater ability to weather short-term volatility and take advantage of compounding returns. Investors with shorter timeframes may need to be more cautious and prioritize investments with lower risk.

The bottom line

You can influence your portfolio returns by considering and managing the abovementioned factors. While there are no guarantees in investing, being proactive and informed can enhance the potential for favorable portfolio returns over the long term.

But you don’t have to do this all alone.

Consider partnering with an Advance Capital Management financial adviser who can guide you in creating a well-structured investment portfolio tailored to your unique financial goals, risk tolerance and time horizon. We can help you navigate the complexities of asset allocation, diversification and risk management in an effort to optimize your portfolio for long-term success.