If you are a typical investor (or financial advisor for that matter), it is possible that the S&P 500 index could do a great deal of damage to your retirement plans. To be clear, the problem with the S&P 500 index is not that it has performed poorly or that I’m predicting that it will perform poorly in the future. The problem is that way too many investors and financial advisors give the S&P 500 stock index way too much power over their financial lives.
What We Usually Do
We get our statements and we look to see our performance compared to the S&P 500. We evaluate potential investments based on how they compare to the S&P 500 the last three or five years (or worse, the last year). And we falsely assume that our long-term financial well-being is tied to how well we are doing in comparison to it.
And then when we’re not satisfied with how we are doing in light of the S&P 500, we really start to get ourselves in trouble. How? We do something.
We watch CNBC or read Money magazine. And then we tweak. And we fiddle. And we start making changes to our investment mix, switching money managers or even switching advisors. But as long as your investment strategy was sound in the first place, these kind of tweaks can often make things worse. Sometimes much worse.
What We Should Do
So where should you focus your retirement investment efforts instead?
You focus on building a portfolio that gives you the greatest probability of meeting your retirement goals (regular and ongoing withdrawals).
OK. But wouldn’t taking steps to improve my portfolio’s rate of return mean that I am more likely to meet my retirement income goals?
The simple answer is, “No.” (The full answer is quite complex, but it is certainly nowhere near a “Yes.”)
You see, when it comes to investing for retirement, you have to decide which is your primary goal. Is your primary retirement goal to beat an investment index like the S&P 500? Or is your primary retirement goal to make regular withdrawals from your portfolio so that you can enjoy your lifestyle for as long as you live?
Depending on how you prioritize those goals will determine the kind of investment portfolio that should be built. In other words, you have to decide if you want to manage to an index or if you want to mange to an outcome. But you can’t very well manage to both.
What do I mean? Let me illustrate.
Let’s say you’re going to make a road trip from New York to LA and you don’t want to over pay for gas. So you ask your travel advisor to map you out a route so that you pay the lowest possible price per gallon during your trip. With that goal in mind she puts together a route that has you drive from one low priced station to another on your way to LA.
And when you complete your trip you calculate your average cost per gallon and determine that it was $2.90. But that information alone doesn’t tell you if your travel advisor did a good job or not planning your route. So you look up what was the average nationwide price per gallon during the time of your road trip (an index) and find out that it was $3.25. So you rightfully conclude that your advisor beat the index and you’re pleased with her results.
Well, that is until you compare notes with your friend Karen who made the same trip as you did at about the same time. Karen also worked with a travel advisor and she ended up paying an average of $3.40 per gallon (worse than the index).
You’re just about to give Karen your travel advisor’s business card when she also happens to mention that not only did she complete the same trip in two less days than you, but her total fuel costs were hundreds of dollars less than you as well.
So What Happened?
Here’s what happened. Karen and her travel advisor had different priorities than you and your travel advisor did. Karen’s priorities were to complete her trip on time and on budget. She didn’t spend time and money chasing low gas prices as she traveled along. And as a result, she put a lot less miles on her car while driving to LA – and that saved her both time and money.
It’s not that Karen ignored gas prices or didn’t care about them. She just didn’t let the possibility of a cheaper price per gallon sidetrack her from her main priorities.
When it comes to building your retirement portfolio, make sure you have your priorities straight. If your ultimate priority is to support your lifestyle for the rest of your life, then building a portfolio designed to beat the S&P 500 may just be a disaster waiting to happen.
Instead, make sure your portfolio is designed with your true priorities in mind. This usually means a portfolio that is well diversified, has an appropriate level of risk and is designed to support an acceptable annual rate of withdrawal. In addition, your portfolio should also be built to compliment other financial products and/or sources of retirement income.
And most importantly, do not use the S&P 500 to determine the temporary success or failure of your overall retirement plan. Doing so might just ruin your retirement.