What’s the right benchmark to measure your investment success?
I’m often asked “What is the right scoreboard or benchmark to use for my investments?” Or, “What is the real measure of investment success?” It’s human nature to compare ourselves and what we have with others, and our investments are a prime candidate for such comparisons.
One common way investors measure investment success is to compare their investment returns against popular benchmarks, such as the S&P 500 Index. Although it can be reassuring to know how your investments stack up to others, this type of comparison can have unintended side effects. When you compare apples to oranges, the end result can mislead rather than help you stay on a pathway to reach your personal goals. In fact, there is a term for this which is common in our industry: tracking error regret.
The Media and Tracking-Error Regret
You will likely feel tracking error regret when your customized investment portfolio does not perform as well as popular market benchmarks like the S&P 500 Index. Even a casual market observer is inundated with the moves of the Dow and S&P 500 Index on a weekly basis (even more so during periods of uncertainty in the markets). The media is replete with eye-catching statements such as:
“The Dow Jones is up 15% so far this year!”
“Emerging markets stocks offer double-digit returns this quarter!”
“The S&P 500 breaks through it’s previous high and is up nearly 20% for 2013!”
If your own portfolio’s growth seems anemic in comparison, you may regret the decisions you’ve made and wonder if you’d best make some changes to go after that greener-looking grass. Before you switch gears, ask yourself: Are you using the right gauge for the measurement? The above figures may be accurately reported, but what do they really mean to you and your wealth?
How Do You Measure Financial Success?
To us, financial success isn’t defined by how closely your returns happen to match a common and arbitrary benchmark. Instead, it’s about you and yours. On those terms, financial success happens when …
You and your family have enough wealth to achieve or sustain your desired lifestyle according to your personal goals.
You are able to focus the majority of your time and energy on doing the things you enjoy with the people you love, instead of worrying about financial headlines.
We achieve this measure of success in several ways. The general rule of thumb is to concentrate on actions you can expect to control and avoid being entangled by those you cannot.
Investing as a Personal Journey
The final point in the table above gets to the heart of why it’s critical to avoid tracking error regret. To offer an analogy, imagine you decide to take a cross-country journey from San Francisco to Boston – except, en route, you want to visit every state that begins with the letter “A.” Working with a professional travel agent, you spend hours charting out the best schedule at the most reasonable prices to achieve your personal goal of adding Alabama, Alaska, Arizona and Arkansas to your itinerary.
You’re all set to buy the tickets. Out of curiosity, you visit one of the popular discount travel sites and you notice they’re running a special on flights between San Francisco and Boston for half of what you’re about to spend.
In this scenario, you’d probably quickly recognize that the popular site’s offer, while ostensibly a much better deal, fails to reflect your personal goals. With only a minor twinge of regret, you’d probably stick to the plans you’d made.
Think of your custom-built portfolio in the same way. Its highest purpose is not to slavishly track a common index, so it should come as no major surprise when your portfolio and its components periodically deviate from their closest benchmarks. Your portfolio should instead be designed for – and measured against – a far greater purpose: You and your desired destinations. If you ask us, that’s the only way to roll.