A Savvy Investor

What Being A Savvy Investor Really Means: Knowing The Return You Actually Need

Naomi is 31, makes a comfortable salary at a marketing firm, and has been investing for about six years. She has a 401(k), a Roth IRA, and a brokerage account she opened during the pandemic and still tinkers with on weekends.

She subscribes to two investing newsletters. She listens to a markets podcast on her run. She knows what the Fed is doing this month. By any reasonable measure, she is more financially engaged than most people her age.

Ask her how she’s doing, and she’ll tell you she beat the S&P last year by about a point. She’s proud of that, and she should be. Ask her one more question, the question I’ve been asking people for 30 years, and she goes quiet.

What is your investment return objective?

What percent return do you really need? Not what return did you get. Not what return did the market get. What return, on average over the long term, does your portfolio have to deliver for the life you want to actually work?

I’ve worked with hundreds of people like Naomi. Smart, engaged, doing more than most. And I’ll tell you the pattern I see constantly: the people who answer that question well end up with more options, less anxiety, less risk, and a portfolio that fits their life. The people who can’t answer it well are playing a game without knowing the score.

This article is about how to answer it.

Start With The Destination, Not The Portfolio

Most investors do this backwards. They pick investments first, then hope the investments get them somewhere. Some look for a homerun. That’s an upside-down approach.

Sophisticated institutional investors don’t work that way. When Apple invests in developing a product, they’re not asking what the latest trend is. They’re asking what return on equity they need to keep and attract shareholders, and which products in their portfolio give them the highest probability of hitting that return.

You can run your investment portfolio the same way:

• Start with the life you want.
• Calculate the wealth that generates the cash flow that supports it.
• Subtract the wealth you already have.
• Look at the time you have to build the rest.

The math tells you what average annual return your portfolio needs to deliver over the long term. That number is your long-term investment return objective.

When building the wealth you need, the Wealth Building Formula® makes this concrete.

C x T x % Return = $$$

Where C is your investable cash you need to save, T is time, % Return is your long-term investment return objective, and $$$ is the wealth that will generate the cash flow you’re building toward. The percent return variable is the one most investors never define. Without it, the rest of the equation is a guess.

Why Beating The Index Is The Wrong Scoreboard

I’m going to say something that sounds Unorthodox: beating the S&P 500 last quarter is not a measure of success.

It feels like one. People love to talk about their wins. At a backyard barbecue or a casual hangout, you’ll hear, “I bought Apple at $40, I’m up 400%.” You never hear about the position that didn’t work. So the social scoreboard rewards selective memory, and the real question never gets asked.

The real question is whether you’re on track to reach your wealth goal in the time period you set. There will be years above your target. There will be years below it. What matters is the average over the long term and the probability that your plan works.

A person aiming for a 6% long-term return who gets 9% in a hot year and 3% in a flat year is on plan with the risk profile they like. A person aiming for “beat the S&P” who gets 11% in a year the S&P but got 12% might be “losing,” even though the absolute return was strong.

Their risk adjusted return may not be what they want to live with every year. But they don’t know that, and it may come back to bite them someday. One of those people is measuring something useful. The other is measuring something that has nothing to do with their life.

This is what sophisticated institutional investors understand and most individual investors don’t. The benchmark, and the risk associated with it, is what matters. And the benchmark that matters is your own plan.

The Cash Flow Lever That Lowers Your Required Return

Here’s where the methodology connects across topics in a way most people miss.

Suppose you have a $100,000 portfolio and your Wealth Building Formula tells you that you need a 6% average annual return to reach your goal. Now suppose you do the work we covered in earlier topics. You find $200 a month in subscription leaks. You renegotiate your insurance. You move into a smarter use of debt. Suddenly you have additional investable cash you didn’t have before.

What does that do to your required return?

It lowers it. Because you’re feeding more C into the formula, the % Return variable doesn’t have to work as hard to deliver the same $$$. You might be able to drop your target from 6% to 5%, or even lower.

Lower required return means lower required risk. That’s not a small thing. That’s the difference between a portfolio you can sleep with and one you can’t. It’s the difference between staying invested through a downturn and panic-selling at the bottom.

Naomi, when we worked through this, realized she’d been targeting a number well above what her plan actually required. She’d been taking on risk she didn’t need to take. Once she ran her formula, she dialed her allocation down a notch. The same plan worked. She just stopped taking on risk she didn’t need.

The Six Rules That Keep You Out Of Trouble

Once you know your long-term investment return objective, the rules for getting there are pretty simple. They’ve held up for 30 years.

Set a reasonably attainable return objective. The phrase “reasonably attainable” is doing real work. If your formula tells you that you need a 15% average annual return, you don’t have an investing problem. You have a planning problem. Adjust the inputs. More cash flow, more time, less wealth target, or some combination. Don’t reach for a return that requires you to swing for the fences every year.

Let compounding do the lifting. Money needs to stay invested long enough for compounding to become the major driver of your wealth. Pulling money in and out, or taking on undue risk, can interrupt the math.

Invest for the long term, even when it’s hard. A lot of people say they’re long-term investors. Then the market drops 15% and they’re calling their adviser at 9 a.m. Long-term investing means not changing course because of short-term moves. That’s the discipline.

Don’t try to time the market. Nobody has ever done this consistently and successfully. And the cost of getting it wrong is bigger than people realize. DALBAR’s Quantitative Analysis of Investor Behavior, a study published every year since 1994, has consistently found that investors who react to short-term market moves give up between roughly one percent and as much as 6.5% per year in lost returns compared to those who stay disciplined. That’s not a rounding error. Over a 30 year horizon, even the low end of that range can cut a portfolio’s end value roughly in half.

Only make investments that let you sleep at night. If a portfolio is technically optimal but emotionally unbearable, it isn’t optimal. You’ll abandon it at the worst time. Match the risk to the return you actually need and to what you can carry without losing sleep.

Make all portfolio allocation decisions based on your long-term investment return objective. Not on what the market did last quarter. Not on what a podcast host is excited about. The number from your Wealth Building Formula is the input. The allocation is the output. Reverse that order and you’re building a portfolio around something other than your own life.

How To Think About Risk

Risk and return move together. The higher the rate of return you choose, the more risk you take. The lower the rate of return you choose, the less risk you take. This is not opinion. It’s how markets work.

The practical move is to start with the return you need, not the return you want. Then ask whether you can live with the risk that comes with it. If you can’t, you have two choices. You can lower the return target, which usually means finding more investable cash somewhere else, extending your time horizon, or adjusting the lifestyle target on the back end of the formula. Or you can keep the return target and accept the risk consciously, knowing what you’re signing up for.

Modern portfolio theory, which won Harry Markowitz a Nobel Prize, gives us the framework. You can build a portfolio that targets a specific return at the lowest possible risk by diversifying across asset classes that behave differently from each other. Stocks, bonds, and other categories don’t all move at the same time. Combining them dampens volatility without giving up the return you need. You reduce risk by not putting all your eggs in one basket. That’s the simplest possible version of a theory that has shaped how institutional money is managed for decades.

What it means for you: a diversified portfolio aimed at your specific return target is almost always going to outperform a concentrated bet on whatever’s hot, measured over a long enough time horizon. Not because diversification is magic, but because it survives the years when concentrated bets blow up.

Who Is Actually On Your Side

One more piece of the picture that most investors never get told plainly: not every person calling themselves an adviser is held to the same standard.

A Registered Investment Adviser, or RIA, is a fiduciary. That’s a legal designation. It means they are required to act in your best interest, all of the time. They have to do what is right for you, not what is acceptable or what pays them more. A broker who is not an independent RIA isn’t held to that standard. Brokers operate under a lower bar called “suitability,” which means a recommendation has to be appropriate for your situation but doesn’t have to be the best option available.

The difference matters. An independent RIA who doesn’t sell proprietary products and doesn’t take compensation from the fund managers or insurance companies they recommend is the cleanest version of this. The only fee they receive is from you. That alignment is what fiduciary means in practice.

When you’re selecting an adviser, ask three questions. Are you a fiduciary? Do you sell proprietary products? Do you receive any compensation from the funds, managers, or insurance companies you recommend? The right answers are yes, no, and no. Get this in writing. Anything else, keep asking until you understand what you’re actually paying for.

A Story That Closes The Loop

Years ago I worked with a young physician named Aidan. He’d just finished his specialty training and the financial influencers in his world were telling young doctors to pay off all their debt and brace for hard times. He came in with that script in his head.

We told him the opposite. Keep the debt, look at your cash flow, build a plan around what you actually need. He pushed back: why was everyone else saying the other thing? The honest answer is that influencers tell people what’s easy to hear. We told him what we’d seen work for over thirty years.

Over the next twenty years Aidan built a successful practice and several other businesses. He’s well-off now, but more importantly he lives the life he wants. He still asks the question. He still knows his number. He still doesn’t chase whatever was on a podcast last week.

That’s what a long-term investment return objective gives you. Not a guarantee of any specific outcome. The clarity to make every other decision well.

Application Box: Amin’s One-Page Investment Reality Check

The hardest part of investing isn’t picking stocks or funds. It’s not knowing what you’re aiming for.

Behavioral research is consistent on this: investors with a written, specific target stick with their strategy through volatility at much higher rates than investors without one. The written number creates what behavioral economists call a commitment device. It’s a small piece of paper that protects you from your future self at 9 a.m. on a bad market day.

Try this exercise. Take fifteen minutes and answer four questions in writing.

• What is the lifestyle I want, expressed as an annual dollar figure I’d need to support it?
• How many years do I have to build the wealth that supports that lifestyle?
• How much investable cash do I have now, and how much can I add per year?
• Based on those three numbers, what average annual return does my portfolio need to deliver?

If you don’t know how to do the math, that’s fine. The CakeClub® app does it for you. The point of the exercise is to make the number visible to yourself. Once it’s visible, three things happen. You stop chasing returns you don’t need. You stop panicking over short-term moves that don’t change the long-term target. And you start seeing every dollar of cash flow you find as a direct lever on the risk you have to take.

That’s not investing advice. It’s investing infrastructure. Build it once and every other decision gets easier.

Want to keep improving your financial habits? Check out our Financial Education Library.

Ready to start getting clear on your financial goals? Download CakeClub® in the App Store.