Aloha
I recently had the pleasure of vacationing in Hawaii with my family. I try to detach from work while away but I admit that I did sneak a peak at my retirement account a few times in between Mai Tai’s. Pulling up my account balance while overlooking black volcanic rock cliffs and a white sand beach in beautiful Kapalua Maui put things into a different perspective than sitting in my office in Colorado. This got me thinking about how to look at performance.
Evaluating Performance
What are the possible ways to frame investment performance? I can think of three ways to evaluate how your portfolio is doing.
The most simplistic way is a measurement versus an absolute benchmark. Examples are versus zero (did I make or lose money?), versus inflation (did I gain or lose purchasing power?), or versus a risk-free investment (did I outperform Short-Term Treasuries?). This is an absolute return mentality.
Another approach is to compare your returns to something else, usually an index of stocks and/or bonds or other subjective things such as your friend’ portfolio, etc. This is a relative return mentality.
Finally, one can take a goal-based focus by looking at returns versus what is needed to achieve your life’s desires within your financial plan. I refer to this as a relevant return mentality.
Who Are You?
What do you compare performance to? Do you just want positive returns? How important is beating the S&P 500? Are you just happy that your plan is on track? Knowing your return preference is important because it should align with the type of portfolio you have. A disconnect can cultivate poor investor behavior and cause the abandoning a winning strategy and not achieving your life’s desires.
So what kind of return preference do I have? Well, as I sat and looked at the beautiful beach houses (see below) and thought of my desire to one day live in one of them, it was clear. I want returns that will get me that beach house and the lifestyle it represents. I don’t care about a stock index, Jim Cramer, or anything else. It’s simple. Are my returns keeping me on track to living in that house overlooking Oneloa Beach in Kapalua Maui and achieving other goals for me and my family? I’m definitely a relevant return guy.
Takeaways
Investors are typically their worst enemies. The ability to stick to a plan and investment strategy is critical to the success of any financial plan. A primary contributor to not following a plan is having a disconnect between the type of portfolio you have and your return preference. Deploy portfolios you can stick with not just regarding risk tolerance but also the type of returns you can stomach.
It’s hard to tell someone that their preference is wrong. However, I always remind clients to put returns into a perspective focuses on the “end” of investment performance, not simply the “means.” Benchmark whatever your beach house is.
Gregg