When you’re trying to evaluate whether your portfolio is on track to meet your goals, it’s important not to get too distracted by the headlines of the daily financial news. While the short-term performance of indexes like the S&P 500® and Dow Jones Industrial Average can be useful in determining the general mood of certain US stock market investors in the present, they are not necessarily a good benchmark for the performance of your overall investment portfolio or your ability to reach your goals. Comparing your portfolio to the performance of these indexes is unlikely to give you a clear picture of how your portfolio has been performing so far or what it is likely to do in the future.
If you’re wondering how best to gauge your progress toward your goals, here are 3 steps you can take to efficiently and effectively assess your investments. With a firm understanding of where you are financially, you can better identify opportunities for adjustment—or feel more comfortable that your current strategy is right on the money for your long-term needs.
1. Make sure you have a clear definition of success
Before you can assess whether your portfolio is on track for success, you first need to have a clear definition of what success means to you. Whether you’re managing your investments on your own or working with a professional investment management team, chances are that you’ve made your investments with a specific, long-term goal in mind—say, saving for retirement or funding a major expense like buying a vacation home or paying for a child’s college education.
“Ultimately,” says Scott McAdam, an institutional portfolio manager with Strategic Advisers, LLC, “your aim should not be to beat a benchmark, it should be to reach a certain dollar amount that helps you realize your goal in the long term.”
Whatever your goal might be, it likely informed how you’ve allocated the assets in your portfolio among the various asset classes. For example, a goal that lies far in the future might warrant a more aggressive asset allocation, one that emphasizes assets like stocks, which carry the potential for more risk and volatility but also offer the potential for growth that can be essential to meeting more ambitious goals. In contrast, a shorter-term goal, such as something you expect to pay for in the next 3 to 5 years, may be better served by a more conservative asset allocation that is weighted more toward lower-risk assets such as bonds. How your investments are allocated across various asset classes should reflect a risk level based on maximizing your chances of achieving your financial goals rather than aiming to maximize returns.
“When considering long-term growth potential in a portfolio, US and international stocks can be a viable option for portfolio diversification and potential growth,” says McAdam. “However, they can be volatile, so it takes a degree of tolerance for risk to be able to ride out the more difficult periods in the market. So while we try to maximize the potential for growth, we also add other investments that aim to perform differently than stocks during those periods of volatility. Historically, bonds have served as a good shock absorber relative to stocks, though other assets, such as commodities, real estate investment trusts (REITs), and alternatives may help as well.”
If you know that your portfolio is allocated in accordance with your goals, you should be thinking about the performance of your portfolio in relation to that goal—not necessarily what’s going on in the markets today. And if you aren’t sure that your portfolio is allocated in accordance with your goals, it’s time to sit down and develop an investment strategy that is aligned to your time horizon, your tolerance for risk, and your long-term objectives.
2. Understand how to use benchmarks appropriately
Once you’re confident that your portfolio is allocated in accordance with your goals, you can then start to assess how it’s doing and whether you need to make any adjustments. To do this, you need to break your portfolio down into its various asset classes and then compare the performance of each asset class to an appropriate benchmark.
What does this mean, exactly?
Well, consider the S&P 500 index. As mentioned previously, this index may not be a useful benchmark for determining how your portfolio is performing. Why is that? It’s because the S&P 500 is composed entirely of stocks—and your portfolio most likely isn’t. “If you’ve got a well-diversified investment plan and you’re trying to measure it against the S&P 500, that’s an apples-to-oranges comparison,” says McAdam.
The S&P 500, however, may be a good benchmark for the performance of the US-based stock investments in your portfolio, just as the Bloomberg Barclays US Aggregate Bond Index may serve as a good gauge for your US-based bond investments. If you were to take either of these indexes and compare them to your entire portfolio, you might end up with a skewed sense of how your investments are performing—either too well or not well enough.
McAdam suggests that it may also be wise to consider the risk profile of the benchmarks, rather than just returns. While you may find that a particular benchmark is outperforming your investments, it may also be exposed to more risk than you are comfortable with and therefore wouldn’t be something to necessarily gauge your own portfolio against.
3. Take a step back and consider the whole picture
If you have multiple accounts or assets held across multiple firms, it can be easy to lose sight of the whole picture. But to effectively evaluate your progress to your goal, you need to include all the accounts you intend to use for reaching that goal. For example, if you are using an asset location strategy, you may have your asset classes spread across multiple accounts rather than mixed in together to help ensure greater tax efficiency. Imagine you have 2 accounts of roughly the same value: An individual brokerage account, which has a 100% stock allocation, and a retirement account, which is 60% in stocks and 40% in bonds. While both the brokerage and retirement accounts have the potential for growth, the brokerage account—due to its higher stock allocation—is more likely to experience greater growth during periods of strong market performance.
Overall, the collective performance of the 2 accounts may be in line with what’s expected from your asset allocation, and despite the appearance of underperformance in the retirement account, you may still be on track to meet your long-term goals. Additionally, if you are sharing a goal with a spouse or partner, an accurate assessment of your progress will require incorporating their assets into your assessment.
It’s about planning, not prediction
The reality of investing is that you can never predict what markets might do. You can only prepare for it. “It’s important to maintain a long-term perspective,” says McAdam. “The various components of your investment plan may go up and down, and sometimes they may beat the benchmark, while other times they may underperform it. But what’s important is that you are getting closer to that dollar amount that will help you pay for the lifestyle you want in retirement or to cover the goals you’ve planned for.”
A well-diversified portfolio designed in accordance with your goals and personal preferences may help afford you the best opportunity to take advantage of long-term, compounding growth while also helping to protect you against the drawdowns and volatility that can shake your confidence. With a clear sense of your long-term desires, the knowledge required to appropriately evaluate your performance, and the perspective to keep everything in balance, you may feel more confident about your ability to assess how your investments are progressing toward your goals.