This post was originally made on July 17, 2006 on a former blog of mine.

The one thing I have never quite understood is the need for performance comparison against a benchmark. I don’t mean comparing a single mutual fund to a benchmark. What I mean is comparing an individual’s portfolio return to a benchmark. If you are investing in a fund that is supposed to mirror the S&P 500 then by all means check to see if it is doing so. However, if you are an individual with many different assets in a portfolio and many different goals then why would you compare those returns to the returns of a simple index?

When you think about it, indexes have one simple goal. That is to grow over time. They do not experience life transitions like humans. They do not have kids that go to college or daughters who get married and want expensive weddings. They do not ever think about their quality of life and how that would be improved with a cabin at the lake. No, indexes have a single static goal and that goal never changes.

We, as people, experience many transitions in our lives that call for far more planning than to simply say “grow my assets”. There are times when we need to be more conservative with our investments and times when we need to be more aggressive. In my opinion a good financial advisor is one who examines the goals of a family’s life and then helps them to create a financial plan and investment portfolio that will do the best job of getting them to achieve those goals. Forget the benchmark. How are you doing against your personal goals for your life?

Some people call it matching your future assets with your future liabilities. I prefer to think of it as matching your financial plan with your life plan. If you sit down a few times a year with your financial advisor and look at how your assets are growing in relation to your goals then it should not matter if you beat the S&P 500 by 2% or lagged by 2%. As long as you are reaching your milestones does it really matter?

The risk/reward concept is sometimes difficult to grasp for people who have never studied finance. It’s easy to say that you need to get a greater return for taking more risk but most people simply do not understand that taking more risks means you will have wider return swings than “the market”. The market has a single risk/reward profile. Investing in it (using some ETF or mutual fund) means you have virtually the same risk/reward profile. If, however, you and your advisor determine that you need to be more aggressive with your investments (in order to meet your GOALS) then your returns should NOT look like the market returns at all. If they do then you did something wrong. Comparing an aggressive portfolio to the S&P 500 index is just not realistic but, time and time again, investors with aggressive portfolios will see that their assets were down 6% when the S&P was down 4% and be furious. They think that the increased risk is only supposed to help on the upside, not be more painful on the downside.

Individuals and families have so many different variables factored into their portfolio construction that comparing their returns against simple benchmarks to me seems ludicrous (I suppose I am in the minority on this opinion). Seeing where you are relative to “the market” may be comforting but it may not provide a good perspective on the quality of your financial advice OR on your investments as a whole. It all depends on the nature of your needs and goals.

Suppose you had a daughter who came to you and said she got engaged and wanted to get married next year. Your financial planner may advise you to move some money into a more conservative environment in order to make sure you that you have enough to pay for the wedding in a year. If the market decides to go on a monumental bull run during that time then your total portfolio may lag the market because the wedding money was in a savings account or CD. Does that really mean you lagged the market from a life goals standpoint? It’s all a matter of perspective. From your advisor’s standpoint he must educate you about the nature of risk and return. From your standpoint you should really care about one thing. Am I making progress towards the goals set out in my life plan? Forget about the S&P 500. It has other aspirations.

“Use your money to make a life rather than using your life to make money.” -Mitch Anthony

Leave a Reply