Falling Barometer: It's Time to Stop Expecting 20%-Plus Returns - TheStreet

Please return to your seats, ladies and gentlemen, we are now beginning our descent.

No, not the markets. They've been in a downward mode for the better part of this year. The descent we are experiencing -- or should be experiencing -- is the downshift in investor expectations for mutual fund returns after four straight years of 20%-plus returns in the market.

Let's go to the numbers: Last year, the average domestic U.S. stock fund rose 27.7%, while the

average

tech fund returned 135%, according to

Morningstar

. Such jaw-dropping numbers had investors expressing disappointment at the notion of 40% returns for the year. While newer investors may think 20%-annual gains is the measuring bar for an average year, consider that the market has returned about 8.4% on average during the past 50 years.

This year may have been a disappointing one for investors (even though many market watchers think this digestion period was very necessary), with the

Nasdaq Composite Index

off 14.8%, the

S&P 500

down 5% and the

Dow Jones Industrial Average

off 10.7%. However, it provides a good time for investors to rethink what kind of returns they should expect from their funds and portfolios, and how to determine if they are doing well. While a nice barometer would be to hope your fund can beat the broader market (not an easy thing), you should expect your fund to handily beat inflation levels.

"Most people attempt a long-term strategy but they tend to be short-term focused, and unfortunately, they appear confused," says Pittsburgh-based financial planner Lou Stanasolovich. "So you try to get them to focus on a return over inflation. That's the most important thing."

The bursting of the tech-stock bubble has been a wake-up call to those who had come to expect sky-high returns for years to come, but now investors should step back from the market's wild gyrations and stay focused on their long-term goals, say financial planners.

Stanasolovich says investors should aim for a diversified portfolio that will give a return of 3% to 5% over the rate of inflation. Investors should look at their returns over a three- or five-year period, rather than just focusing on one-year gains, he says.

How does Stanasolovich gauge performance against the broader market? He compiles an average of different indices, including the S&P 500, the

Russell 2000

, the

Lehman Brothers Aggregate Bond Index

and the

Morgan Stanley Capital International Index

among others, and comparing investors' returns to that.

"On a combination basis, it's tough to find a decent benchmark, so we run a combination of all of them and divide them equally," he says. The planner says his formula may not be the greatest in the world, "But it's some attempt to measure what might be a reasonable asset allocation portfolio." (For more on pegging your mutual fund's performance to the appropriate benchmark, check out this

primer.)

Steven Weinstein, a certified financial planner with

Arthur Andersen

in Chicago, draws up a similar type of performance measurement for his clients, developing a benchmark that includes the indices that appropriately represent the securities in the investor's portfolio.

"Generally we start off with each client having an investment policy, and that will give us a target asset allocation. From there, we would construct a benchmark for the total portfolio," says Weinstein.

Weinstein says he often further refines that benchmark by looking at how some portfolio managers are performing compared to their category peers.

Though he compares client portfolios to their relevant indices, the Chicago-based planner cautions that investors shouldn't get too hung up on competing with indices because the indices don't include taxes or fees that investors pay.

A different approach is taken by Melbourne, Fla.-based financial planner Daniel Moisand, who urges his clients to set their own long-term investment goals and pay little heed to the ebb and flow of the markets.

"We have to get clients to create their own benchmark which is relevant to what they have going on in their own lives," says Moisand. "You can set specific percentage goals, like 8%

return over the next 10 years, and that's more meaningful."

And while something like an 8% return might have been more than attainable in recent years, Moisand says the market's volatility of late goes to show that perhaps having more moderate expectations is the prudent way to go.

"They also have to keep in the back of their mind that nobody can predict the future," he says.