All too frequently, we hear “I’m in great shape, I’ve outperformed the S&P for the last four years,” or something similar. As financial advisors, though, we can’t help but ask ourselves: When did the S&P become the single metric by which we measure financial success?
We believe there are a few reasons why this is flawed thinking.
We’ll touch on three:
- the importance of determining the rate of return you need
- how cash can help save you, and your portfolio, from yourself
- the one factor that can have a far greater impact on your net worth than any market index
The key to this whole exercise is having the resources to live the life you want and leave the legacy that’s important to you—right?
Well, how does the S&P know what’s important to you? It doesn’t, so its rate of return may not match your needs.
Let’s say the S&P is returning 8 percent this year, but you know you need only 6 percent to accomplish your goals. Why take that additional risk? Knowing what you need and being laser focused on it is the key to your success.
Another question: How can you plan well if you don’t actually know what you’re planning for? Of course you care about your net worth, but the more important number is what you spend. And, no matter how much you make or how much you have, one simple truth applies: Folks have a tendency to spend more in retirement.
Sure, you may be done paying for tuition and your mortgage, but we find that in retirement, people have more time to spend, so they often do spend more money. And, the expenses you’ll have will dictate the size of the nest egg you need to retire successfully. Know that, and you’ll know where the goalpost is. Simple. But profound.
Cash is also simple, yet profound. So, consider this: If you have a cash reserve that is sufficient, when a downturn happens, you’ll be insulated from those drops. How? You won’t have to sell equities, fixed income or alternatives to raise cash, which would lock in losses as the market goes down. You won’t even have to look at the S&P, because your losses will stay on paper, where they belong.
Perhaps the biggest reason these types of metrics are highly imperfect is the “stuff happens” factor. In fact, a market downturn is not the biggest risk to your portfolio—life is.
Imagine this scenario: You’ve invested well and have outperformed the S&P for years, leading to a wonderful cushion for you and your loved ones as you age. Then you or a family member gets sick, has an accident or has other big-ticket needs, and you’re not properly protected. All those decades of great returns are wiped out overnight. Remember, this is a marathon, not a sprint: You need to plan to have a rate of return that is good not only this month, but until the end of your life. And, increasingly as we age, that means not beating the market, but protecting what we have.
Every financial plan is a puzzle, and the financial, familial and emotional pieces all need to fit together to make things work. Consider what pieces you’ll need to fit together, and don’t worry so much about arbitrary, external measures. This is why we say that managing money is the easy part. Managing life, on the other hand, requires some serious work.
The views expressed here reflect the views of Joseph S. De Sena and Katie Coleman as of November 1, 2015. These views may change as market or other conditions change. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances.
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™ and CFP (with flame design) in the U.S. Investment advisory services and products are made available through Ameriprise Financial Services, Inc., a registered investment adviser. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon and risk tolerance. Past performance does not guarantee future results and no forecast should be considered a guarantee, either.
The Standard & Poor’s 500 index (S&P 500® index), an unmanaged index of common stocks, is frequently used as a general measure of market performance. The index reflects reinvestment of all distributions and changes in market prices, but excludes brokerage commissions or other fees. It is not possible to invest directly in an index. Ameriprise Financial Services, Inc., Member FINRA and SIPC. © 2015 Ameriprise Financial, Inc. All rights reserved.
This article was originally published in the December/January 2016 issue of Worth.