Global Growth Investor - The Home Of Growth Investing

Monday, June 23rd, 2008

Setting good trading goals, part I

2 comments

One of the most important things traders can do is set appropriate goals. In the next few posts I’ll outline some of my own and others’ thoughts on setting good trading goals.

The first step is to work out some type of benchmark to measure yourself against. This is usually an index. I don’t want to go into which benchmark to pick in depth; but the point of trading is make more money than you could by putting your funds in cash, or bonds, or a share index. That’s after broker fees, data costs, taxes etc. Otherwise it’s a waste of time … or a hobby.

According to Jeremy Siegel, in the Twentieth Century, nominal US stock returns were 9.9 per cent annualized, bonds 4.85 per cent and bills 3.86 per cent. According to the authors of Triumph of the Optimists, US stocks’ real return from 1900 to 2002 was 6.3 per cent. So over the past hundred years or so, stocks returned roughly 9 to 10 per cent in nominal terms, and 6 to 7 per cent in real terms.

But there is no guarantee those returns will be repeated this century. Indeed, many including influential writer William Bernstein, believes returns will be lower over the next 20 to 30 years. He believes stock will generate a real return of around 4 per cent; in nominal terms that equates to around 7 per cent.

To justify trading, including time and costs, we need to beat the market by a comfortable margin. It’s up to each trader to add their cost and tax estimates onto what they think the market will deliver.

Let’s be very optimistic and assume that stocks will return 10 per cent in nominal terms in the next 20 to 30 years. I think that means a trader should be generating returns of at least 15 per cent after taxes and costs. That translates to around 12 per cent in real terms. If we’re more pessimistic (like William Bernstein), then we should shoot for around 10 per cent nominal return, and 7 per cent real return.

That may shock some traders as being very low. But remember over the long term few genuinely beat the market. We have pretty efficient markets working against us, and I actually advocate that traders hedge their bets a bit and have a fair portion of their retirement account in index and bonds funds, as I do.

But that doesn’t mean we should give trading away. One of the benefits of trading is that even if you don’t always beat the market, you can be consistent. Research shows that stocks have not outperformed bonds over some 20-year periods. You’re going to be considerably poorer if your retirement coincides with the end of that period.

But if you’re banging out 10 per cent a year from trading consistently, you’re protected from that; i.e. trading is a hedge against your index funds going into a long-term slump.

So in summary, I think if you’re generating around 12 to 15 per cent a year, after tax and costs, you will be doing amazingly well.

Share This

Word Count: 509. This entry was posted on Monday, June 23rd, 2008 at 7:30 am and is filed under Investing psychology, Trading goals. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.