Choosing your performance benchmarks

"If you don't know where you're going, you might end up somewhere else." - Yogi Berra

Benchmarks are a necessary evil in the portfolio design process. The evil part is that benchmarks can be arbitrary and capricious if they aren't chosen thoughtfully. You might end up chasing after a rainbow instead of keeping an eye on the signposts ahead.

The necessary part is that bench-marking is the only way an investor can tell how well or poorly they're doing. The ultimate benchmark is the one that shows whether the investor is on track to meet heir objectives on time. This is a hard one to design, but it can be done with a little thought and effort.

Compared to what?

Stop me if you've heard this one before. A guy walks into a bar, looking disheveled and grumpy. He sits down next to a neatly dressed, friendly patron who turns to him and asks "How're you doing?" Mr. Grumpy snaps back with "Compared to what?"

And that's the plight of the average investor. When I get a new client I always ask them how they're doing in the market. Replies range from "not very good at all" to "I'm absolutely crushing the market" and everything in between. The only relevant reply would be "compared to what?" This is where benchmarks come in handy.

​

Simple Benchmarks

Ask 10 people what their investment goal is, and 9 of them will say "beating the market." This is among the most useless investment goals imaginable. Which market? Beat it by how much? What makes you think you have an edge in the market?

Everybody wants to beat the market, but very few can do it with even a modicum of consistency. Wall Street pros depend on beating the market for their substantial end-of-year bonuses. Hedge fund operators depend on it because they take 20% of the profits. And dilettantes want to have bragging rights at their high society cocktail parties.

Not only is beating the market a useless goal, it's downright dangerous to your success as an investor. It forces you into short-term thinking and takes you away from your real goal, which is meeting your objectives on time.  

Real Benchmarks

In the 1st lesson of Module 3 we covered how to calculate your MRR - minimum rate of return. This is the only benchmark that has real value. Are you ahead of schedule, or are you behind? If your MRR is 8%, why would you care about beating the market? You just have to match or beat 8%.

If you're behind schedule you may have to take on a little more risk. If you don't want to do that, you may need to delay your retirement. Or maybe the market will bail you out. But you don't have to try to beat the market. 

If the market has a bad year like 2008, and is down by 37%, does it advance your goal if you are only down by 27%? You beat the market by 10 percentage points, congratulations. But you fell behind schedule with your real goal.

Choose your benchmarks wisely

In the end it all comes down to one thing - getting to your objective safely and on time. If you orient your thinking in this way, you'll never have to be the grumpy guy in the bar who says "compared to what?"