Choosing the best investment benchmark will help you properly evaluate your portfolio and retire with confidence. By using inflation as your benchmark, you can ensure you’ll have the cash you need to maintain your ideal lifestyle goals in retirement.
Inflation reduces the value of your hard-earned money every day. In other words, one dollar today, is worth less tomorrow.
By stuffing your money in cash form or in a low return(<1.00%) savings account you are guaranteeing a negative real return. Therefore, it is important to track inflation with diligence. If we don’t, it can easily destroy our hard-earned wealth and jeopardize our retirement plan.
What is an Investment Benchmark and How Will it Help Your Financial Plan?
A benchmark is a point of comparison, or a tool we can use to evaluate the performance of our investments. We monitor inflation by using it as our investment benchmark on performance reports. This allows us to compare the real values of our client’s money over time.
How Will Your Financial Plan Look Without a Benchmark?
Imagine you bought some shares of stock in Facebook, Tesla, Netflix, Google, etc. Over time, the price of your stock went up. Maybe you made a few hundred dollars. Maybe you made a few thousand. Regardless, you’re pretty excited because you made some money.
Good for you!
But, what’s your benchmark? What could you have done in the same amount of time? Was there a better alternative?
When you invest without a benchmark, it’s nearly impossible to answer these questions.
IMPORTANT INVESTMENT BENCHMARKS
If you’ve ever received an account statement on the performance of your investments, you’ve likely seen a benchmark before. One very common investment benchmark is the S&P 500 Index. The S&P 500 contains a broad mix of U.S. stocks of large companies. As a result, looking at the S&P 500 can tell you the investment performance of those 500 large U.S. companies.
There are multiple other benchmarks besides the S&P 500 that track the performance of different markets.
There are benchmarks for stocks of large companies trading in the United States, like the Dow Jones Industrial Average. There are also benchmarks for stocks of companies in international countries, like MSCI EAFE.
How the Use of Benchmarks Created the Modern Day Financial Planner
A long time ago, the idea that you could plan out your life and optimize your finances to achieve your personal goals didn’t exist. In place of financial advisors, there were professionals known as “money managers” or “investment managers.” These people would take your money and, if they didn’t screw up too badly, turn it into even more money. Of course, it’s difficult to measure whether an investment manager screws up or not without a point of comparison.
Enter investment benchmarks.
At the time benchmarks were first popularized, investment managers weren’t just trying to grow wealth to keep up with inflation and match the market. They touted their ability to “beat the market” or help you earn a better return than the masses were earning overall.
Of course, over time, it became evident that these investment managers could not beat the market. It was also determined that investment managers didn’t determine investor return as much as the cost of investing did.
As a result, savvy investors have largely moved into low-cost investments today. If you can match the benchmark and keep your investing costs extremely low, you can do well in today’s investing environment.
The Bottom Line for your Financial Plan
These days, personal finance has become much more sophisticated than investing alone. Instead of looking at just one piece of your life (your investments), financial planners are able to look at everything in your life that involves money.
This includes things like:
- Managing risk using the right type of insurance
- Estate planning to make sure that your money has a plan in your absence
- Tax planning so you don’t overpay the IRS
- Retirement planning to help make work optional
- College planning
- Cash flow and expense tracking
As financial advisors started helping their clients manage more than just investments, the way that we look at investments has changed, too.
Investing is no longer only about making the most money possible. Investing has become about managing risk and knowing you won’t run out of money in retirement.
With all of this in mind, it’s smart to use inflation as your point of comparison when you look at your investments.
Why?
Because the S&P 500 (or any other investment benchmark) has little to do with how you are going to be able to achieve retirement, nor can it tell you if you’re on track to accomplish what you want in life.
Your money will have less purchasing power in the future. However, you can use that knowledge to your advantage.By keeping track of inflation with respect to your investments and using a Certified Financial Planner or CPA, you can ensure you’ll have the cash you need to reach your lifestyle goals in retirement.