What Determines Investment Returns?

Quiz!

Which of the following are factors that determine investment returns (may be multiple answers)?

1. Past known world events.
2. Central bank actions.
3. Future unknown world events.
4. Valuations

What Determines Investment Returns?

Most investors focus on one factor when trying to predict investment performance: past world events. In reality, investments are impacted by different factors, including: future world events, central bank actions (the Fed in the US), momentum, valuations and the natural growth of companies. Here are a few scenarios that tend to surprise investors and lead to unexpected results:

1. Recently there was a negative event that led to declines. The next day brought a positive event along with gains. The reverse also happens.
2. Recently there was a negative event that led to declines. A central bank (the Fed in the US) took actions to support the economy, leading to optimism and gains. Even as little as indication for future support can lead to gains.
3. An investment is more likely to continue its trend of recent months. A high investment can keep going higher and a low investment can keep going lower.
4. An investment with low valuations is likely to enjoy greater than average gains in the upcoming 5-10 years. In addition, it is more likely to revert from negative momentum to positive momentum.
5. Beyond all factors above, you can expect diversified stocks to grow on average, thanks to the productivity of the underlying companies. It doesn’t happen in every specific day, month or year, but it happens on average, supporting long-term investors. And it happens more (on average) for certain groups of stocks including: small companies, cheap stocks (low valuations), and emerging markets.

Quiz Answer:

Which of the following are factors that determine investment returns (may be multiple answers)?

1. Past known world events.
2. Central bank actions. [Correct Answer]
3. Future unknown world events. [Correct Answer]
4. Valuations [Correct Answer]

Explanations: Past known events are already reflected in stock prices. Read this month’s article for further explanations.