How do you define investment success?

Too often we compare the performance of our portfolios with a benchmark, such as the S&P 500 Index. We may think: The S&P 500 was up 10% last year, so why was my portfolio only up 6%? The S&P 500 may seem like a reasonable performance benchmark. After all, it’s the most widely discussed proxy for U.S. stocks and stock market returns. While this index is a standard benchmark for returns, it’s typically not the right benchmark for your portfolio, especially if you are diversified between stocks and bonds.

Required Return: a better benchmark for success

A better proxy for success is your required return, which is an output of your financial plan. Your required return is based on your financial situation, including short and long term goals, risk tolerance, tax situation, cash flow, and expected capital contributions or savings. Your required return is essentially the average return necessary to meet your most important objectives. It’s a vital part of developing an asset allocation that balances your risk tolerance and return objectives. Good news is that for most of us, our required return is often far more modest than a 9% or 10% desired return. That is good news, since most of us would probably have a hard time enduring the volatility of an all-stock portfolio.

Everyone’s situation is different

Keep in mind that everyone’s situation is different. Your required return is based solely on your personal investment plan, which will look different from another person’s plan. Your required return drives your asset allocation decision, helping you build a balanced portfolio that can appropriately moderate both risk and volatility.

To recap, a required return is always a better proxy for investment success over a desired return. A desired return, such as a return based on the S&P 500, will likely steer you into taking unnecessary risk as you are tempted to chase returns. Most investors have portfolios more balanced between stocks and bonds, so a performance comparison with an all-stock index (such as the S&P 500) is bound to disappoint.


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