Investing and managing retirement income is a little bit like trying to get in shape.
It would be great to run with marathon phenomenon Eliud Kipchoge—or just finish 26.2 miles—but focusing on performance is often a fool’s game. It is far better to focus on outcomes, specifically those that make sense for you.
Save more for retirement
When certified financial planner Patti Brennan meets with new clients, she asks them if they are “outcome driven,” or “performance driven.” People who are outcome driven target a specific return tailored to their investment needs and risk tolerance. Those who are focused on performance typically seek to match or beat an often-arbitrary benchmark, most often the Standard & Poor’s 500 index (.SPX).
It’s easy to understand why people get caught up in performance: Investors are inundated with news about the S&P 500 and other tallies of returns. When the market is going up 20% a year, a 10% return seems like a failure.
“It’s one of those things where I tell people [who are performance oriented] to be careful what you wish for,” says Brennan, who is president of Key Financial in West Chester, Pa. If the goal is to keep up with the market, she says, that also means being able to ride out the inevitable declines.
Your rate of return
For several reasons, being performance driven can set up savers for failure even before they get started. For one thing, while a person is accumulating their retirement nest egg, their actual rate of return likely won’t look the same as the market’s over that period. “Even if you had 100% of your money invested in the S&P 500, your performance will not be what the S&P 500 did because not all of the money was in that account the entire 12 months,” Brennan says.
In other words, if you start the year with $1,000 and systematically put $500 a month into the account, even if you earn a 20% return calculated daily, you’ll have about $7,800 at the end of the year. It isn’t quite the same as earning a 20% return on $7,000, which would leave an investor with $8,400.
Meanwhile, markets rarely steadily move up: Double-digit upside usually comes with comparable downside. What investors also overlook is that recovering from a 10% loss, for example, requires more than a 10% return.
Consider the difference between a $10,000 investment that averages a 10% annual return over three years and one that gains 30%, declines 10%, and bounces back 10%. A casual glance suggests the results should be the same. Yet the 10% steady return will be worth $13,310, says Brennan, while the more volatile option ends up at $12,870.
“After a 10% decline, she says, you need to make more than 10% the next year just to break even,” she says.
And this assumes that an investor actually sticks with the program. Most people don’t have it in them, as studies by Dalbar, a consulting firm, have shown year after year.
In 2018, Dalbar’s research shows, the average investor in an equity fund lost twice as much as the S&P 500. The average person took money off the table—an apparently savvy move as stocks flirted with bear-market territory—still lagged the index in the second half of the year because of poor timing.
Dollar cost ravaging
Being outcome-driven is particularly important in retirement. Savers have been told to embrace the beauty of dollar cost averaging, the strategy of investing at regular intervals, regardless of what is happening in the market. When markets are high, the same dollar amount won’t buy as many shares, but investors benefit when prices fall because they are able to buy more. It all averages out.
It doesn’t work like that when people are tapping their retirement assets, as Blackrock has noted, calling the phenomenon “dollar cost ravaging.” Because retirees are drawing on their savings—not adding to them—market declines take a much bigger toll.
Sticking with it
It turns out that more than half of Brennan’s new clients say they are outcome oriented, and that’s a great starting point. Yet it also has its challenges, particularly when the stock market is blazing. “When they get their [portfolio] reports and they see they’re underperforming the market, that’s when the real stuff comes out,” she says, noting that some of the more challenging points of her career have been during stock-market booms. “A good portfolio is like a garden,” Brennan says. “When it’s truly diversified, something is always in bloom.”
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