By now, you’ve read the entire book (hopefully) and understand some key guiding principles for selecting an appropriate benchmark for your retirement investing plan.
And no, there’s no benchmark recommendation in this chapter either. Sorry—I did warn you. Instead, this chapter pulls together each chapter’s high points as a reference to guide you.
I’ve given you some principles and concepts for selecting a benchmark—you must now use them to determine for yourself what’s appropriate without succumbing to rules of thumb that may sound commonsensical but can actually harm you long term. Or you can use this as a guide to improve your communication (and hopefully, the results) with a professional. Up to you.
Picking an appropriate benchmark isn’t trivial. It’s yours for a good long while, unless something very major changes. Which is why I can’t give you a cookie-cutter solution. But if you put in the work—or work with a professional who understands the importance of selecting an appropriate benchmark and then managing against it—and if you remain disciplined to an appropriate plan, you can increase the odds you achieve your long-term goals. You can indeed get the prosperity you plan for.
It’s not easy. It’s quite hard! If someone tells you otherwise, they’re deluding you and/or themselves. But as I’ve said throughout the book, it’s not hard because it’s necessarily very tactically hard. It’s hard because your brain didn’t evolve to do investing easily. And every single day can be a battle against your instinct to cower in fear or greedily chase hot returns—if you let it. Perhaps the biggest benefit of an appropriate benchmark is it can aid you in remaining disciplined.
How so? Remember there was a reason you selected that benchmark. It wasn’t driven by whim or a magazine survey. It was the result of careful consideration. You chose it (or it was chosen for you or with you by a professional) because it was appropriate for you and your goals. So through good times and bad—however tempted you are to stray—remember the benchmark, if chosen carefully and appropriately, should increase the odds you get where you need to go over time.
Said another way, deviating materially (for reasons other than material changes to your circumstances and goals) may not end up helping and in fact can end up hurting. It might help alleviate some near-term pain—either because downside shorter-term volatility is uncomfortable or you feel you’re missing out on gains somewhere else. But that likely matters much less later on if you discover you’re not close to where you planned to be.
So choose wisely and well—then remember how and why you chose, and stay disciplined.
To increase the likelihood of reaching your retirement investing goals, you need a benchmark—picking an appropriate one is critical and the very aim of this book.
A good benchmark is :
A good benchmark is not :
The benchmark is the backbone of your long-term investing strategy. Every decision you make should be relative to it. The first decision is whether you want to be active or passive. (The questions later in this chapter can help you answer that.)
For example, if you decide your benchmark should be 100% equities and you want global exposure (a good idea for equity investors), you could invest everything in an ACWI ETF—then never touch it for the rest of your investing time horizon. Maybe you add to it as long as you’re in your earning phase, and then you sell bits of it occasionally in retirement for cash flow. That makes you identical to your benchmark for as long as that benchmark is appropriate—that’s passive investing.
This is tactically easy, but, in my experience, many more investors believe they can do true passive investing than actually do it successfully. Make no mistake, in practice, passive investing can be very, very hard to do. (See Chapter 2 of this book or Chapter 17 of my 2010 book, Debunkery.) And if you have a goal of beating the market (i.e., your benchmark), as many investors do, it simply can’t be done via passive.
If you decide to do active, you must decide whether you have the time, knowledge, expertise and/or fortitude to do it yourself, or if you want to hire a professional. Then, too, you can decide (or your professional can help you decide or decide for you) when and where and how you want to deviate from your benchmark. (Again, this book isn’t about investment strategy tactics. For that, I point you to the update of my 2007 book, The Only Three Questions That Still Count, which walks you through a strategy for how to make bets relative to a benchmark.)
But you can’t choose a benchmark yet. Not until you’ve done the following.
Your investing goals are key to selecting an appropriate benchmark. You should be able to state them simply, though they can cover a wide array of objectives.
At a very high level, most investors’ goals fall into one of these broad buckets:
For the most part, and for most investors, goals shouldn’t be any more complicated than that.
What about “capital preservation and growth”? In reality, as discussed in Chapter 2, capital preservation and growth are two separate and inherently conflicting goals.
To get growth, you must accept some level of near-term volatility risk. True capital preservation requires complete or near absence of volatility risk. If you have a growth goal and implement it well, over a very long period, you likely will have grown your assets and thereby also preserved your capital. But that means experiencing relatively shorter periods of downside volatility—the opposite of a capital preservation goal. Be very wary of any strategy that purports to satisfy both goals at the same time.
There are other goals you can accomplish via financial planning, like insurance and estate planning. However, for the most part, you don’t want to commingle insurance needs and an investing strategy.
There are some products, like variable annuities, that purport to grow your assets (like an investment) while providing a death benefit (like an insurance contract). However, combining the two often means increasing costs and doing neither well. You are best served, in my view, if you buy insurance (cheaply) for insurance needs and buy securities to meet investing goals.
To know which benchmark can increase the odds of achieving your long-term goals, you should know where you’re starting from and what your future needs are. To do that, do a few exercises like:
You can’t get a benchmark recommendation from a book. Nor can a book give you an appropriate asset allocation recommendation—the book doesn’t know you, your situation or goals. It can’t possibly. (It’s a book.)
However, you can use the concepts and principles provided here to help you determine what’s appropriate for you or aid in a conversation with a professional.
Remember: An appropriate benchmark should help you increase the odds you achieve your long-term goals. An inappropriate benchmark might seem like a good idea initially but could set you up for major disappointment down the road.
What’s more, in conjunction with determining an appropriate benchmark for your goals, it’s critical you understand the risk and return characteristics of that specific benchmark so you can understand—and be prepared for—how much shorter-term volatility you’re likely to experience. Volatility isn’t bad—finance theory says to get growth, you must experience volatility. And don’t forget, volatility goes both ways—up and down. But shorter-term downside volatility can sometimes be difficult to experience.
If you’re working with a professional, an additional benefit they can provide is helping you understand expected risk and return characteristics of an appropriate benchmark. And he/she can also help you remain disciplined when times are tough. As discussed in Chapter 2, failing to stick with a strategy is one major error many investors make, and it can seriously erode portfolio return over time.
What are the driving factors determining an appropriate benchmark? Primarily:
Start by determining time horizon, which is:
Then, consider your return expectations.
Next, consider if you have cash flow needs.
But that’s not all—there are other criteria, unique to you, that might impact a benchmark decision. E.g.,
Ignore rules of thumb about age being the primary determinant for asset allocation. Your age figures into your time horizon but ignores your spouse and your potential longevity. This rule of thumb also ignores your return needs, your cash flow needs and other unique factors. It’s much too cookie-cutter and assumes all investors of a same age are in the exact same circumstances with identical goals.
At a very high level, the more growth you need—whether to satisfy a growth goal or to ensure your assets stretch enough to cover cash flow needs—the more equities you need in your benchmark. But expected volatility must be weighed against cash flow needs.
A good tool that can help determine probabilities of portfolio survival given different growth assumptions and cash flow levels is a Monte Carlo simulation. You can build one yourself (if you have the data) using Excel, find one online or ask a professional to do one. Whether you use a free online model or have a professional run simulations, check how the model is constructed. You want it to use ample data going back far enough (preferably 1926—as far back as we currently have good S&P 500 data), and you want to run many iterations for multiple scenarios. As discussed in Chapter 6, I prefer a bootstrap scenario, which in my view is more reflective of reality.
If you’ve decided creating and managing an investing strategy is beyond your interest or ability and/or you simply don’t have the time, choosing the right adviser becomes critical.
There’s no boilerplate right answer here, either. Some folks want to make most of the decisions themselves and need only an adviser who can sell them appropriate securities. Others want more extensive help. Either way, the following questions can help you better understand the capabilities of the person or firm you’re considering hiring. Ask at least the following of anyone you interview:
Since portfolio asset allocation is a critical decision made for my account . . .
Global market leadership has always shifted and will continue to shift over time . . .
Static and/or rigid allocations to size, style and/or sector mix or other categories can mean missed opportunities and can hamper performance ...
The right manager’s interests are fully aligned with mine ...
Another key benefit of having an appropriate strategy and reasonable expectations: It can reduce the odds you become a victim of a financial fraud.
Never assume you’re not an attractive mark for a con artist. If you have money, whether 100 bucks or $100 million, that’s feed fuel for a con artist’s game—and they’ll do anything to keep a con running. If you have reasonable expectations, a strategy you’re disciplined enough to remain with and aren’t motivated to chase pie-in-the-sky (but possibly false) returns, it’s very tough for a con artist to swindle you.
As investors, we’re often concerned by the return on our money. But ultimately, if you fall for a scam, your loss can be total. Sometimes, the return of your money is more important than the return on your money. Know the signs of a possible fraud:
Understand what’s reasonable to expect, and you can avoid falling into a con man’s trap.
This is only the very start of your journey. I hope you use what you’ve read here to better guide you to an appropriate benchmark for your retirement investing plan.
Investing is very difficult. If it weren’t, there’d be no need for this book, any of the others I’ve written or any of the thousands more written over the years by others. The industry wouldn’t have spawned countless products, myriad sales and service people and firms globally that exist solely (or primarily) to service and advise investors. It’d be like falling off a bike. Anyone could do it, and they would, and we’d probably all be much wealthier.
And even if you have a good plan and an appropriate strategy, it’s still not easy. Our brains weren’t set up to do this well. We’re plagued constantly by conflicting cognitive errors. If you find investing difficult, you’re normal. If you find it easy, you’re kidding yourself. If you can acknowledge investing is hard and counterintuitive and a lifelong battle, you likely have a bit of a leg up over your peers.
But that’s why you need a plan. And the earlier you establish one, the better off you can be. Create a good plan and select an appropriate benchmark—and then invest using that benchmark as a road map—and you remove one major uncertainty from investing. You won’t be stabbing in the dark collecting a variety of products and hoping the mix all turns out ok in the end.
So good luck, and enjoy the journey to your prosperity.