‘Return on Effort’ May Be the Most Underappreciated Metric in Investing
Whether in-person or in online communities, investors love to brag about their portfolio returns. They will dissect earnings calls, monitor valuations and price-to-earnings ratios, back test hypothetical portfolios, and debate the merits of different asset classes all in an attempt to achieve the highest possible return.
But rarely do these investors stop to consider their return on effort. At its core, return on effort is a measure of the amount of time, attention, and emotional bandwidth an investment demands relative to its financial payoff. And in an era where do-it-yourself investing has never been more prevalent, this overlooked metric might be one of the most important differentiators between a quality investment that is either worth pursing or a waste of time.
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Time, after all, is a finite resource. And any investment that commands a disproportionate amount of your time without offering commensurate returns is arguably underperforming on an ROE basis.
Consider that over the last year, Nvidia’s share price has had 18 single-day moves of greater than 5%. Yet, over that same 12-month period, the stock still finished up nearly 50%. Meanwhile, an investor who traded in and out of the stock—or layered on options positions—likely missed at least a couple of those big daily swings, and in practical terms would have been better off buying the shares outright and holding for the duration.
The world of investing is full of overly complex strategies that promise outperformance but rarely beat the simplicity of buying either a broadly diversified index fund or a basket of individual stocks and letting time do the work. This is not to say that active investing or tactical positioning has no place. But too often, investors confuse complexity with sophistication.
A strategy that demands constant maintenance may not only drain your time, but it is also likely to reduce your results. The more time and energy an investor dedicates to monitoring trends and adjusting a portfolio accordingly, the more susceptible they become to buying high and selling low.
Burton Malkiel—the author of A Random Walk Down Wall Street—famously noted that an investment portfolio is like a bar of soap: the more you handle it, the smaller it gets. Thus, assuming that a more active strategy must be a better one (simply because it sounds more complicated) can lead the savviest investors to spend countless hours tinkering with their portfolios while generating marginal outperformance.
Just as the Sharpe ratio helps investors evaluate whether they’re being adequately compensated for the risks they’re taking, there should be a similar framework for measuring the return on effort. The Sharpe ratio does not dismiss risk entirely; it simply asks whether the end justifies the means.
Likewise, investors need to develop their own barometer for whether a particular strategy is worth the time and attention it would demand. This means accounting for financial volatility, the hours spent monitoring positions, and the opportunity cost of attention diverted elsewhere.
Besides, complexity rarely comes cheap. Strategies that boast about returns that are uncorrelated from the public markets (e.g., private equity, venture capital, private credit, hedge funds, etc.) tend to carry substantially higher management fees than average. And once additional costs for things like leverage, trading, and performance fees are factored in, the gross return that seemed attractive on its face can shrink meaningfully by the time it appears on your statement.
An investment that delivers only a marginally better return than a passive alternative, yet requires exponentially more upkeep and/or expense, is likely not worth the tradeoff. The smarter alternative is to favor strategies that compound quietly in the background while giving you back your time. Measured that way, the best performing portfolio may be the one that delivers solid returns and leaves you free to focus on everything else that matters more.
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Malcolm Ethridge is the Managing Partner at Capital Area Planning Group, based in Washington, D.C. His areas of expertise include retirement planning, investment portfolio development, tax planning, insurance, equity compensation and other executive benefits.
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The information provided is for educational and informational purposes only, does not constitute investment advice, and should not be relied upon as such. Be sure to consult with your legal advisors before taking any action that could have tax and legal consequences.
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