We enter the holiday gathering season with U.S. stocks up nearly 30 percent, pushing toward five years of this bull market run. When the going is good, people are more comfortable sharing their performance at the company cocktail party, club get together or family event.
Certainly, people have more winners to talk about now.
Some will share how they’ve made great gains with an investment or two. Maybe you have also. Or maybe you’re a conservative investor, and you feel like you’re not participating in the market gains to the same extent as others.
Neither outcome matters much if you don’t keep in mind two important elements of your investment strategy — your goals and an appropriate way to measure performance of your whole portfolio (not just the winners).
Investment returns should only be evaluated in relation to your goal, not how one prominent slice of the market is doing or how your neighbor has fared.
LET YOUR GOAL GUIDE YOU
What is it you are trying to get to and how are you doing? When you know your target, you can put recent market performance in proper context. Have returns (whether up, down or sideways at any given time) changed the probability of reaching your goal? To know, it helps to have documented goals.
The goal should not simply be a number. It should be a carefully chosen and wisely pursued mix of lifestyle decisions, spending preferences, savings capability and investment approach. For someone approaching retirement, the goals might read like this: We want to retire at 62 and begin the third part of our lives. We plan to live in our current house which is paid for, but we know that it will need upkeep and maintenance. We expect that we can live on $60,000 per year of after-tax income but we know we’ll need more in the first decade or more of active retirement. This amount will come from our savings, Social Security, a pension, and distributions from our retirement plans.”
Generally, people who feel most prepared to make money decisions think in these terms, or get help to define them, so that they have something to measure progress toward. A proper reflection of goals is definitely a bigger picture than hoping to outperform the Dow Jones Industrial Average or the S&P 500.
PERFORMANCE IN CONTEXT
When you are comfortable that you’ve defined your goals, then you can go a layer deeper to measure the effectiveness of your investments, first collectively and then individually.
Ignore headlines of the Dow or S&P 500 at record highs. That’s nice for one piece of a diversified investment strategy, but it leaves you well short as a comparison point for a well-balanced approach.
A simple way to measure your performance compared to a relevant benchmark is to identify a target risk index that fits your investor type (i.e. conservative, moderate, aggressive). Or, target retirement date benchmarks can act as an appropriate guide for many people who base their investment mix on how near they are to retirement. You can find performance reporting for each of these approaches – among many other indexes – at Morningstar.com in the markets section.
When you know how your broad portfolio is performing compared to a relevant benchmark, then you can go to the individual holding level to review which holdings are contributing the most to your portfolio performance and which are detracting relative to an individually appropriate comparison. Again, Morningstar provides category-specific information to evaluate each investment.
CHASE AND YOU MAY NOT RECEIVE
When reviewing investments amid chatter of big gains, be careful to avoid the trap of chasing performance due to short-term thinking.
Following the recent leaders is rarely the way to go.
Over the past 15 years, according to market researcher Craig Israelsen, investing on Jan. 1 in the previous year’s worst performing asset class would have generated a meaningful performance edge over investing in the best asset class over the previous year.
Market performance is not wholly elusive, it can be captured, but it is fleeting. It comes and it goes and no bell rings to signify the top or the bottom. Even professional mutual fund managers don’t beat benchmarks every quarter or year.
You shouldn’t hold yourself to that standard. And if you evaluate in the context of your goals, you may realize you don’t need exceptional returns to reach them.
Positioning for large returns may introduce more risk than necessary, actually reducing the probability of reaching your goals.
Thinking about your investments in the right context you can sidestep the hot tips conversation at your holiday party and instead share how working from a plan with defined goals and benchmarks has given you confidence about managing your money, regardless of which direction the market is going.Gary Brooks is a certified financial planner and the president of Brooks, Hughes & Jones, a registered investment adviser in Old Town Tacoma. Follow him on Twitter @moneyarchitects.