If you have anxiety about the performance of your investment portfolio, you are not alone. Many people wonder if they are making the most of their investments, but there is a good chance you’re in the dark about how to know if your portfolio is performing as it should.
There are a lot of metrics and moving parts; and depending on who you’re talking to, you might be getting conflicting messages or advice. When your neighbor brags over cocktails that their portfolio returned 20 percent last year while yours only returned 12, your gut reaction might be that they’re doing far better than you are, even though they’ve only given you a snapshot of how their portfolio performed in one single year.
The bottom line is, the most important rate of return is the one required to keep your financial plan on course.
Why comparing to a benchmark is a bad idea
First, let’s consider a common misconception. Many people use benchmarking to track the performance of their portfolio and believe this is the best way. The problem with this is that the performance of the market index itself does not reflect your individual financial portfolio, because the index itself doesn’t have to consider factors that are personal to you, such as your risk tolerance, taxes, living expenses, life expectancy requirements, or the impact of inflation on your real dollars invested. Without taking these factors into consideration, tracking benchmarks can leave you falling far short of your goals to achieve financial security.
How your performance should be evaluated It’s best to build your portfolio and track its performance based on what matters most to you specifically — not the arbitrary performance of the market overall. You see, investments are the main tools we have available to financially make our plans happen. In order to choose the right tools, you have to know what job is that you need them to do. A hammer has never been considered the right tool for cutting down a tree. Likewise, a portfolio of speculative investments that don’t pay an income and go up and down like a yo-yo may not be the best investments for someone who is retired and needing the investments to provide an income for their lifetime.
So set your goals. What is it that you need your portfolio to do for you? Create a financial plan based on those goals. Your plan will assume a reasonable rate of return given investment market history, the time you have to achieve those goals, and what your risk tolerance is.
Once your plan is done, then it becomes time to actually create your investment portfolio. When selecting the tools, the investments, to use and which ones not to use, important considerations include:
- Your Time horizon
- Your need for income today, and/or a growing income for tomorrow
- Your risk tolerance
With your investment plan established, you should meet with your financial advisor regularly to review your portfolio’s performance and attributes relative to your personal plan and goals.. What you want to do is track where you are now, versus where you should be, in achieving what matters most to you. That is what is most important. What your portfolio returned last year might be an interesting cocktail conversation, but it doesn’t reveal anything about your overall plan performance.