I don’t know what the market is going to do in the coming months.

I do know we will have weak markets at some point (and I suspect they could be quite messy given the extremes we are now experiencing in the currency, commodity and credit markets).

I also know that investors will not be ready when the downturn comes.

Chris and I are spending lots of time these days talking to clients and prospective clients. What is clear to me is that investors are getting used to positive returns quarter after quarter. Consequently, my hunch is that they will not be psychologically ready when the tide turns. A few down quarters will be quite a jolt.

With the good returns of the recent past, investors have also raised their expectations for future returns. The number I hear most often is 10%. “I’ll be happy with 10% a year...my retirement plan works if I can just get 10% in the future.”

If we pause for a minute, it is interesting to think about what a portfolio needs to look like to generate 10% annually over the next five years. If we assume that current interest rates of 4.5% are a good proxy for future bond returns, then a 10% target points the investor towards an equity portfolio...100% equities.

For an investor with a long time horizon, an all-equity portfolio makes total sense. In many cases, however, the 10% expectation also comes with the words “and I can’t afford to have my portfolio go down... this money is too important to me.” In reality, for investors who can’t risk having a negative return, expectations should be in the 5-7% range.

I’m writing this blog as a ‘kick in the butt’ for myself more than a thought provoking piece for our readers. We want to bring new investors to Steadyhand, but we’ve got to be more direct in discussing return expectations with people... both the magnitude and pattern. Aiming for returns that are well in excess of bond yields will require an equity portfolio and all that comes along with it — big years, bad years, short-term volatility.