Dave Sather's Money Matters: Benchmarking performance
Billy is a good friend from college. When he called, the tension in his voice was high.
His father, "Colonel" Jordan, was driving him nuts with investing questions.
Billy said that because he is a CPA and does his father's taxes, the Colonel was convinced Billy should know about investments, too.
As we caught up, it became obvious we needed to carve out time to evaluate the Colonel's investment plan.
The three of us sat down over coffee. Colonel Jordan started by saying his portfolio only earned 3 percent last year while "the market" was up more than 10 percent.
My first question for Colonel Jordan was, "What instructions have you given your adviser regarding your investments?" The Colonel, a direct man of few words, bluntly said, "Make me as much money as possible."
In my head I laughed, as these are often the first words out of someone's mouth regarding their investment goals. However, I prompted Colonel Jordan to elaborate, especially regarding cash flow needs and tolerance for volatility.
He revealed that he told his adviser to keep $100,000 liquid at all times for an emergency - or in case he wanted to buy something.
I smiled and wondered what the World War II veteran would buy on the spur of the moment with 100 grand.
Jokingly, I asked if he planned to buy a Lamborghini. He stared at me stone-faced.
He also told his adviser that at age 86 he wanted his portfolio to produce an extra $3,000 a month to supplement monthly needs and didn't want a lot of volatility. These were not surprising goals but difficult in today's low interest rate environment.
In reviewing the military veteran's portfolio, I saw he had $100,000 in money market (about 10 percent of his investable assets). He also had about half in a variety of fixed-income mutual funds, and the remaining 40 percent in some diversified stock market funds.
While assessing his assets, Colonel Jordan said he thought his account should have done better. I agreed this allocation should have performed better than 3 percent, and it did.
As I mentioned this, the Colonel was confused. His portfolio was only 3 percent larger because he failed to factor in withdrawals taken throughout the year.
Some simple Aggie math indicated his portfolio actually did about 7 percent.
Although that made Colonel Jordan feel better, he wanted to know if he was getting good performance. He stated that "the market" usually delivers 10 percent a year.
I asked Mr. Jordan if he would be comfortable if his portfolio fell by 40 percent in any one year, much like it did in 2009. He quickly replied "Heck no!"
This was good. We were making progress. I explained that the stock market has performed about 10 percent on average over very long time frames. However, any stock market investor should be prepared to have their stock exposure decline by 40 percent in any one year. As such, if he could not withstand the volatility, it was good he was diversified beyond just stocks.
More importantly, I helped Colonel Jordan understand that a fairer evaluation of performance was not a comparison to just one index but rather a customized benchmark. Billy, who had been quietly listening, asked what I meant.
In assessing performance, certain assets should be measured against other assets of the same nature. It is unrealistic to compare assets in money market to stock market assets or the stock market to the bond market.
The Colonel recognized that money market would be lucky to earn much more than .01 percent. I added that his bond exposure, compared to the Barclays Aggregate Bond Index, should have done around 4 percent. Additionally, his stock exposure should be compared to the S&P 500 Index or the total stock market index. Knowing this, if he continues to require that his adviser maintain similar allocations, he can create his own customized benchmark to track his performance.
Just as importantly, although maximizing performance is important, it must be done in a manner that considers cash flow needs and an investor's tolerance for volatility.
As we finished our coffee, the Colonel said, "Well, thanks for your time. I have a much better idea of how to measure my own performance. Now, I need to go. I might buy a Lamborghini."
Dave Sather is a Victoria certified financial planner and owner of Sather Financial Group. His column, Money Matters, publishes every other Wednesday.