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Three Ways to Measure Your Financial Progress

Do you know how much your portfolio needs to return so that you can meet your goals, keep up with rising costs, and provide a lifetime of income? Adviser Doug Gjerde lays out some points to ponder.

By Doug Gjerde, CFP

How much does your portfolio need to return so that you can meet your goals, keep up with rising costs and last your lifetime? Do you need 3%, 5%, 8%? Do you know?

Consciously or not, we compare the performance of our portfolios to benchmarks. Some of them are not useful, some can be harmful.

Doug Gjerde

Doug Gjerde

Neighbors, Friends, and Relatives?

Jim and Jane are cousins and have been competitive since childhood. As children they competed at sports, board games, and even the prized spot at the holiday dinner table. The croquet games at family reunions were intense. Jim was always aggressive, going for the send shot with glee. Jane played more conservatively and after decades their win-loss tally changes back and forth but stays close to even. In retirement, they keep up the fun and compare portfolio returns.

For 2019, Jim’s portfolio gained 24.6% and Jane’s portfolio returned 15.6%. Jim gloated with his Wednesday coffee buddies because his return beat all of theirs. He delightedly rubbed his higher returns in Jane’s nose too.

Now, part way into 2020, Jim’s portfolio is down 12.2% and Jane’s portfolio is down 1.7%. This year Jim has been quiet about his portfolio during coffee time because he’s been in last place with the group. After asking how his portfolio was doing Jane just smiled and said “see, it is like the Tortoise and the Hare.” She smirked and pointed out that she was ahead over the two year period despite Jim’s stellar performance last year.

Are Indices Good Benchmarks?

Jim and Jane know they shouldn’t make decisions with their savings based on how they compare against their cousin. But they enjoy the ongoing teasing. So, what should they be comparing their portfolio to? Mutual funds compare their performance to stock or bond indexes. If the purpose of your money is to beat the market, as though you are in a footrace against the market, then maybe this is appropriate. But don’t forget the old idiom, “Pigs get fat, hogs get slaughtered.”

If the purpose of your money is to help you live out your values and priorities, what is the value in measuring your returns relative to an external index? Trying to beat an industry index has little relevance to your real life, no more than comparing with your cousin. In some years it makes you feel good, smart and happy. In others, you feel frustrated, as though you missed out or made a mistake. Chasing returns and keeping up with the neighbors are common problems.

You’ve probably heard repeatedly that you should know your risk tolerance. Some of us are risk-tolerant and can tolerate more, like Jim. Many more are risk-averse. You do need to invest within your personal tolerance, so the inevitable swings don’t cause you anxiety. Otherwise, other critical problems happen and behavioral finance research has pointed that out clearly.

But I don’t believe it should end with risk tolerance. We’ve only answered one of the critical questions with tolerance.

Risk Tolerance Isn’t Enough

You also need to have an idea how much risk is required in order to meet your goals and have your money last for your lifetime. For everyone with a good financial plan there is a range of risk and return that fits both their tolerance and their need and it has little to do with industry indices, neighbors or cousins. Financial planning boils down to an exercise in tradeoffs. Proper planning balances wants and needs with resources and reality. It might mean trading off some wants for security and confidence. It also might mean you can accomplish more than you had expected.

I wish I had an easy answer for you but it takes some work and education. You can only determine how much risk you need by having a plan and digging into the details. Planning for spending needs and your other goals while taking rising costs into account is critical if you want to have some confidence. Remember Yogi Berra’s wisdom, “If you don’t know where you’re going, you might wind up someplace else.”

A good financial plan includes what your goals and future spending will cost (factoring in rising costs). Then you work it back to the present using the time-value-of-money. By comparing the future costs to your resources, you can calculate the return you are going to need in order to make all this work out. The result of this exercise provides a more meaningful, personal benchmark than an industry index that has little to do with your life.

Your Personal Index Number

Once again, how much does your portfolio need to return in order to meet your goals and priorities, keep up with rising costs, and last your lifetime?

To determine your number you have three options.

1. Take the time learning financial planning, time-value-of-money concepts, and advanced spreadsheet functions and figure it out yourself. It’s not rocket science but it is a lot of work.

2. You can use the very popular Ostrich method - bury your head in the sand and hope it all works out.

3. You can find a good financial planner and ask them to do the analysis.

All three options have costs; whether time, money, or stress.

In our practice we call the result of this analysis the Family Index Number. It is unique to each family and their plan. It is one of the outputs from a financial and retirement income plan and represents the minimum return (and conversely the minimum risk) needed in order to meet your goals and have your money last your lifetime.

It also provides an indication of whether a plan depends on above-average future returns or can be successful if the market returns less than average in the future. A number like this gives you a measure to compare your progress to over time and presents an early warning sign so you can adjust to inevitable events and changes before the adjustments become drastic.

You have options in how you assess your progress and position. I believe the wrong answer is comparing against other people. Comparing to industry indexes is better, it gives you something but probably has little to do with your life. A more personal measure that is based on your life, your values and your priorities makes the most sense to me.

About the author: Doug Gjerde

Doug Gjerde, MBA, CFP® is Managing Partner, Wealth Advisor of Heritage Financial Partners, 2021 S Webster Ave Green Bay, WI 54301.

Investment advisory services offered through CWM, LLC, an SEC Registered Investment Advisor. This content is for general information only and is not intended to provide specific advice, an endorsement or recommendations for any individual. All examples are hypothetical and for illustrative purposes only. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing. Actual results will vary. For a comprehensive review of your personal situation, always consult with a tax or legal advisor.

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