What's Your Measure of Success?Submitted by Trace Wealth Advisors on September 26th, 2019
I’ve been in the wealth management business for almost 15 years. I would estimate that during that time, I have participated in over 1,000 quarterly reviews with clients. I’ve done them in quarters when the market was up, quarters when the market was down, and quarters when the market was sideways. I’ve done them in quarters when everything worked and I’ve done them in quarters when nothing worked. What all of these quarterly meetings had in common were the metrics used to measure success: performance relative to widely used benchmarks.
The scene is always the same…the client comes in, grabs a presentation book, flips to the second tab of the book (you never lead with performance in this business!), looks at her performance number and looks at the benchmark number immediately below it. If the difference is positive, we spend some time talking about what worked. If the difference is negative, we spend some time talking about what needs to change. I hope and believe that in the brave new world of wealth management, this conversation will become to become a more nuanced one.
The hard truth is that performance compared to benchmarks is a distant second in importance to performance relative to pre-defined goals. This isn’t just a cop out because I don’t want to be held accountable for performance…I do and I should be. But I also realize that if you want to be successful, your goals have to be the primary concern when both designing your strategy and measuring its success.
Consider the following example:
Suppose your child is entering college in 10 years. You estimate that the total cost for the first year is $50,000 (I’m using just one year for simplicity purposes). You currently have $29,000 saved towards this discrete goal. Simple math indicates that you need to generate an annual return of 5.6% in order to fully fund your goal.
Now, let’s assume that you took the $29,000 and invested it with an amazing fund manager whose benchmark generated a 2% annual return over the ten years. As I mentioned, this manager is truly skilled and was able to achieve 2% annual outperformance, leaving your wonderful investment with an annualized return of 4% at the end of the ten years. Your 4% annual return leaves you with just less than $43,000, well short of your goal. This manager generated a phenomenal return relative to the benchmark, but didn’t meet your required return.
Next, let’s assume that you took that same $29,000 and invested it with another fund manager who consistently underperformed his benchmark’s return of 6%. The underperformance amounted to 0.40% annually, leaving you with a total return of 5.6% and the required $50,000 at the end of the ten year period. This manager generated your required return, but failed to provide an attractive return relative to the benchmark.
So this begs the question: which was the more successful investment: the manager whose relative performance impressed you year in and year out or the manager who underperformed but still got you the return you required to meet your goals? In personal finance, you should measure success against your own discrete goals. If you can satisfy those, you can say with certainty that you have been successful. Using the above example as proof, you cannot say the same if the measure of success is beating benchmarks.
What all of this hopefully helps illuminate is that measuring success in investing is both difficult and prone to many of the same biases encountered when choosing the underlying investments themselves. Providing the correct framework through which to measure success is an underrated but essential job of any good advisor.