“The highest form of wealth is the ability to wake up every morning and say: ‘I can do whatever I want today.” — Morgan Housel, author of Psychology of Money

Humans love to compare.

Before social media, we would compare how we were doing by looking across the street at our neighbor’s house.

“Same house, same car, same type of job. We are doing okay.”

Post social media, we can instantly compare our lot in life to billions of strangers.

“They take nicer vacations, have fancier cars, and live in a beautiful mansion. We must be doing terrible.”

Comparing our progress in anything using external benchmarks is a recipe for being miserable.

It is precisely what many retirees do when evaluating their investment portfolio.

How am I doing relative to a random benchmark?

Beat the benchmark. I’m brilliant! Let’s buy more of what’s performing well.

Trail the benchmark. This isn’t working. Let’s try something else.

In my opinion, tracking a benchmark isn’t the worst thing in the world, but it comes with all sorts of unintended consequences.

First, let’s look at the origins of the investment benchmark.

According to Laurence B. Siegel, author and director of research at CFA Institute Research Foundation, a benchmark serves three main purposes…

• Function as portfolios for investors who want passive exposure to a particular market segment.

Example: an investor that wants U.S. small cap value exposure could buy a low-cost mutual fund and/or exchange traded fund (ETFs) that tracks a small cap value index.

• Serve as a performance standard against which to measure the contribution of an active mutual fund manager.

Example: A U.S. large cap mutual fund manager buys and sells stocks trying to beat the S&P 500.

• Act as proxies for asset classes in the formation of a policy portfolio

Example: a college endowment might use several asset class benchmarks to create a portfolio with the desired risk & return characteristics to meet annual giving needs.

There’s no mention of a retiree meticulously tracking their performance relative to a benchmark.

What’s wrong with comparing a retiree’s portfolio vs. a benchmark, say the S&P 500?

Nothing per se, if you know what you’re getting into. For example, the S&P 500 is great for understanding the general direction of the market, but it’s a horrible proxy for most retiree portfolios.

Let’s say a retiree has a 40% stock/60% bond portfolio. The retiree’s goal is to distribute 4-6% of the portfolio each year. Generating modest returns, while avoiding a large drawdown, should allow our retiree to do everything they want to do with minimal risk of running out of money.

If the retiree in the above example started benchmarking their multi-asset class portfolio, which includes 60% bonds, to the S&P 500 (100% stocks) it might result in perpetual frustration.

Aside from the obvious mismatch between a multi-asset class portfolio that includes different types of stocks (foreign, real estate, small cap) and other asset classes (gold, bonds, cash), the biggest risk is the behavior of the investor.

In my experience, the worst behaving investors all obsess over an external benchmark (see “Internal vs. External Focus”).

If they are beating the benchmark, it results in hubris and overconfidence, which can result in buying more of what’s working. This exposes them to unnecessary risk and regret when the cycle turns against them.

If they are trailing the benchmark, they think the portfolio is broken and they need to do something to catch back up. This could result in performance chasing and piling into the hottest themes of the day (see “Hot Themes and Future Returns”).

What should a retiree do instead of rubbernecking a benchmark?

I would ask myself these questions…

• What is my enough? Have I shifted my mindset from building wealth to keeping wealth? (see “What is your Enough?”)
• Where am I fragile? How can I reduce my fragility?
• Does my portfolio mirror my investment personality?
• Am I on track to do everything I want to do without running out of money?
• Do I understand how much risk I’m taking? (see “Is your Portfolio Drunk or Sober?“)
• Can I stick to my asset allocation during difficult markets?
• Am I risking what I have and need for what I don’t have and don’t need?

We’ve mentioned this before, but good investing isn’t swinging for the fences every year. It’s generating reasonable returns over the longest possible time, while being mindful of risk.

Instead of fixating on beating benchmarks, a retiree should place greater emphasis on becoming financially unbreakable.

This quote by William Green author of Richer, Wiser, Happier, captures the fallacy of benchmarks…

“Instead of fixating on short-term gains or beating a benchmark, we should place greater emphasis on becoming shock resistant, avoiding ruin, and staying in the game.”

In my opinion, being able to do what you want, when you want, with who you want is the best benchmark to beat.