By setting unrealistic targets for investment returns, investors can fall into such traps as taking excessive risks and chasing last year's investment winners.

In a research paper, Required or desired returns? That is the question, Vanguard researchers in the US make the point that advisers who help their clients understand the "often-overlooked" difference between required returns and desired returns can provide a valuable contribution to their investment wellbeing.

"On their own, investors often ignore the important planning phase, focusing instead on filling their portfolios with investments featuring attractive recent returns," write the paper's authors, Donald Bennyhoff and Colleen Jaconetti.

"… the financial planning process should result in an estimate of the return needed to accomplish an investor's objectives, taking into account that client's unique goals, time horizon, current asset base, liquidity needs, tax sensitivity, and risk tolerance, among other factors," Bennyhoff and Jaconetti emphasise. These considerations will determine the required target return as against the desired return.

In other words, the setting of a required return is an objective process whereas the setting of a desired return is somewhat subjective.

As Bennyhoff and Jaconetti write, an investor's desired return is usually the product of some external factors that are "largely unrelated" to the investor's objectives and constraints. "In some cases, investors' own experiences may set them on the wrong path …"

Such experiences may include losses on the share market that make the investor highly risk averse – perhaps to that person's detriment. Alternatively, an experience of past success on the share market may make some investors willing to take excessive risks.

How realistic are your investment goals?


By Robin Bowerman
Smart Investing
Principal & Head of Retail, Vanguard Investments Australia
16th August 2013