As I’ve relied less on earned income and more on my investment income the past few years, it’s necessary for me to develop a method of gauging my investment returns. Am I making the right investment decisions? Are my investments severely underperforming? Am I performing too well and maybe exposing myself to excess risk?
I’ve only been investing since 2001, still plenty to learn. Regardless of the mistakes and successes, all that matters is that I’ve met my investment goals; my investments have returned enough to pay for my living expenses.
As index funds have gained popularity, indexers, as they are ceremoniously known, tend to compare their investment performance to the S&P 500. This is a group of a few hundred largest stocks in the US market. Hence, it’s made up of large-cap stocks.
It’s a good index to use but not the only one. Look at the graph below and you’ll see the S&P 500 Index along with the Dow Jones Industrial Average, another commonly reported index. The DJIA only tracks 30 large stocks, but they are among the biggest in the US stock market.
Because the biggest stocks often steer the market, there is a huge similarity between the S&P500’s long list of stocks and the 30 biggest stocks in the US markets.
To complicate things. Many of these indexers have a lot of their net worth in real estate, cash, bonds, and even REITs. So why compare it to the S&P500? Simplicity, perhaps.
Carefully Curated Indexes
What I have learned is that all of these indexes are man-made. Often by a gang of dudes who get together over bourbon and decide which stocks should make up their particular index. Some funds are voted off and others are voted on.
Naturally, if you’re designing an index, you want it to signal a shift in the market to the consumers who follow it. You’re not going to pick some shitty little company which is drowning in debt. You’ll select companies with heavy footprints which move the market.
So if you’re going to compare yourself to a particular index, remember that it’s a synthesized list of stocks which change regularly. If you’re benchmarking your investment returns to such an index then you’re aiming at a moving target.
Benchmarking Your Investment Returns
I need to benchmark my investment returns to something. I can’t just invest in whatever the hell I’m investing and get no feedback.
A good financial advisor should have a feel for the market. They can give you a sense of how your investment portfolio is doing. You obviously don’t want to be toward the very top of the chart because that would mean you’re taking on too much risk. And too little risk means you’re missing out.
Because I consider myself an investor I’m willing to lose everything I’ve invested in the markets. Such is the nature of investing. No risk, no reward.
I could keep my money in a CD instead but I would still have to benchmark the performance to something. Maybe cash? Or perhaps inflation?
Instead of using an external index to benchmark to, what if I set a personal finance goal for myself and gauged my returns based on that?
If my goal is to have a decent cash flow from my investments then I can benchmark my investment returns to the desired income. If it’s real estate that I’m holding, who cares if the value of the house goes down as long as the rental income is coming in?
If I’m investing in index funds and I see it grow year after year, why care if I notice a 20% dip every few years? The value of the index funds is going up. I even see some dividend yields from the stocks, bonds, and REITs.
Budgeting for Lifestyle
This internal benchmarking reminds me of this whole lifestyle stuff I talk about. If I’m living the kind of lifestyle I enjoy then I don’t care if my condo isn’t fancy. If I don’t need a car to live a comfy lifestyle then why own one? Trying to match external standards leads to misery.
So I look around and see the stuff I own. I inspect my living conditions. I take stock of how much money I have and the condition of my clothes and if that meets my fancy then it satisfied my benchmark. Works for me.
There is nothing wrong with investing conservatively in nothing more than a CD or government bonds if your investment provides you with adequate returns. Looking over at how others are performing with bitcoin, crowdsourced investments, real estate, or options trading won’t add any value to you.
Basic Investment Return Guidelines
Back in the 90’s bond returns were in the 6-7%. Not anymore.
Then again, in the 80’s inflation shot up to the double digits.
During each phase of your investment timelines it’s good to have a basic idea of what investment returns should be for each of your holdings.
For example, if you’re speculating on real estate or raw land then you should know what a realistic expectation is. The benchmark might be how your local market has performed over the past few years and how it will likely perform moving ahead.
If you’re investing in rental income property then you might be paying attention to the Capitalization Rate. If you’re investing in a global REIT then you might use a Shiller Housing Index to evaluate your performance.
Meeting or Beating
You don’t have to beat the index. It’ okay if you underperform the index. I use it as a guide to give me a sense of how my investments are doing. This is especially useful since I’m still rather new to the investing game.
Once I meet my investment goals then I need to curb my greed and move some of my money into less risky investments. This is why I have been looking at CD’s the past few months and building up my emergency funds.
Ignoring the Behemoth Stocks
My final comment is that the S&P500 and The Dow are currently being led by the tech giants. Several of these companies aren’t even all that profitable. Yet their digital value supersedes their bank accounts.
Whether this is unperceived value, future value, or nothing but investor sentiment, I’ll never know. However, if these highly valued stocks come crumbling down does that mean that my investment portfolio is done for? No.
I am diversified on multiple levels. From the investment side to the income side I have tried to build in a little bit of redundancy. I’ll let you know how it worked out for me in about 35 years.
FINRA: List of common benchmarks.
Vanguard: Extensive list of benchmarks.
Kitces: Financial planning goals vs investment benchmarking.
FINRA: calculating your investment performance.