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What Everyone Misses About Tracking Their Retirement Investments

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A term you often hear in the investment business is benchmarking, the practice of measuring the return of a fund against a market index.

You probably do this unconsciously. You might notice that the S&P 500 or the Dow Jones Industrial Average is up for the year and compare it to your own retirement fund’s 12-month return.

We’re only human, right? Yet relying on benchmarks can be a big mistake, especially when it comes to planning for a long and successful retirement.

Benchmarks are more complicated than most people understand. For instance, a target-date fund that holds more bonds than stocks is almost certainly going to underperform the overall stock market.

Relying on benchmarks can be a big mistake, especially when it comes to planning for a long and successful retirement.

Yet that sedate target-date fund will be less volatile than the market, too. When stocks fall sharply, the bond-heavy fund should fall by less.

Which raises an important question for retirement planning: Are benchmarks even relevant?

For instance, if you knew that your cash spending needs would be covered by income from your portfolio (or a pension, Social Security or all three), would you care if your investment return exceeded the stock market this year or next?

A step further, if you knew that your spending plus inflation is covered by your expected income, would you even check it against a benchmark?

Probably not. And that’s the difference between benchmarking and investing to cover a liability.

Investment firms use benchmarks to measure their own performance year to year. They are motivated to demonstrate the value of their fees. That’s because they must compete with index funds, which match the market return at a very low cost.

A retirement investment portfolio, however, should be focused on facing up to the actual cost of living in retirement — your specific, personal liabilities.

A retirement investment portfolio, however, should be focused on facing up to the actual cost of living in retirement — your specific, personal liabilities.

If you broke down those liabilities into buckets, you might learn that 60% of your spending in retirement is fixed and unlikely to vary much year to year, other than the typical bump from inflation.

Another 25% might be your vacation fund, money you intend to spend on your children or spending on a hobby. Purely discretionary.

A third bucket, say 15%, could be healthcare spending, which is not fixed at all. In some years you will be healthy and in others there could be costly challenges.

Importantly, inflation will vary for each of these categories year to year. Healthcare inflation, for instance, has been faster than overall inflation for many years now.

Managing goals

Since liabilities are not comparable and their individual inflation rates vary, we should invest for each differently. We should consciously adjust our willingness to take on investment risk for each spending bucket.

You can put off buying a new car or taking a trip to Paris. You can’t put off a medical procedure. A single investment approach can’t manage both goals.

You could face sudden, unexpected expenses as well. We have to cover that, so cash or cash equivalents are part of the investing equation.

United Income is developing ways to monitor inflation on each of these spending buckets and help you invest accordingly. We’re going to be looking at spending needs in particular and investing for that.

The end result should be liabilities covered and far less worry. If you want to measure it against the stock market, too, that’s okay, but that shouldn’t be your starting point for this important process.