Market insights and analysis

By Jerry Wagner

This time of year, plenty of people pack up for a weekend escape and head “up north”—to a lake, a cottage, or just a change of scenery. It’s a familiar summer ritual, especially here in the Midwest. It’s also the time when many investors receive their quarterly performance reports. Naturally, the big question is: “How did I do?” But the answer depends on what you're comparing your results to.

Too often, investors and media alike default to benchmarks like the S&P 500. But if your portfolio wasn’t built with that level of risk in mind, or if your goals are entirely different, comparing your return to that index can be misleading at best—and discouraging at worst.

At Flexible Plan Investments (FPI), we believe benchmarks should reflect the investor, not just the market. That’s why we created the OnTarget Investing process—to provide each investor with a personalized benchmark that aligns with their goals, time horizon, and risk profile.

Why the right comparison matters

Outside of their vacation plans, most investors want to see that their investments have also gone “up north” of whatever benchmark they have in mind. But that raises an important question: What benchmark should you be aiming to beat?

There’s no one-size-fits-all answer. Market commentators often cite broad market indexes like the S&P 500 because they’re simple and familiar. But those indexes aren’t tailored to be relevant to each investor.

That’s where personalized benchmarking becomes essential. A meaningful benchmark should reflect not only your portfolio’s composition but also your financial goals and the level of risk you’re willing (and able) to take on.

What makes a benchmark relevant?

In all of the states where going “up north” is popular in the summertime, heading that direction in the winter is not nearly as appealing. More residents of these states and others would rather “go south” at that time of the year.

Similarly, while it may be appropriate to compare the aggressive profile of a particular strategy to the S&P 500, it’s not appropriate to compare a conservative, moderate, or balanced strategy to such an index. In fact, since most of our strategies exhibit less risk historically than the S&P 500, one could conclude that it is never appropriate to compare our dynamically risk-managed strategies to an index that experienced multiple greater-than-50% losses in the past few decades!

In such cases, the S&P 500 is not a benchmark but rather an indicator of the market environment. It can help answer how that strategy performed in a stock-friendly environment or, alternatively, in a volatile sideways regime. But since a conservative investor would never put their investments solely into the stock market, the S&P 500 should never be the benchmark for success of a conservative strategy.

The OnTarget Investing process

We make all of this “standard” information available to financial advisers on our research, illustration, composite performance, and our firmwide GIPS-verified information. Our composite performance and GIPS reports detail how strategies have performed historically. But in enlisting an investment advisory firm, you are also gaining access to its research team and its ability to adapt and improve even the seemingly best strategy.

On our account statements, we use the latest research report benchmarks with the current fund rules to prepare a personal benchmark for each client account. We call it our OnTarget Investing process. You can visit the OnTarget Investing website to learn more, but here is a brief overview.

The process begins with the suitability questionnaire that clients complete as part of their investment management agreement with us. Pairing each client’s answers with the strategy or portfolio of strategies chosen by each client and their financial adviser, we are able to create a personal benchmark for what they indicate will be the time horizon of their investment.

This is provided to clients in the initial proposal. By doing so and then delivering it with each future account statement, we provide clients with a personal, customized measure to judge the subsequent performance of their account.

Here’s how.

Each client’s personal benchmark is best represented by the OnTarget Monitor (see the sample below).

The OnTarget Monitor uses hundreds of Monte Carlo simulations of your portfolio against the strategy’s benchmark. The portfolio value (the black line) is plotted against a color-coded projection of possible investment outcomes over your stated time horizon.

The multicolored background represents the probability that your account will reach the forecast composite benchmark values on the right with your current strategies. The “composite benchmark” combines the benchmarks of the strategies used in your account in the percentage allocated by you. The black line represents the account’s monthly percentage change, after deducting advisory fees, and ends with the current balance. The chart’s time period matches the time horizon in your suitability questionnaire.

What we refer to as OnTarget performance is achieved by those portfolios where the black line falls within the blue and green zones.

While a bear market can throw even the best of strategies or diversified portfolios briefly into the red or yellow zones, prolonged duration in the red zone suggests a discussion with your financial adviser to choose a better combination of strategies.

In addition, we put each client’s portfolio into perspective with our Volatility Barometer (see the sample below), which measures the volatility (standard deviation) of each client’s actual portfolio versus the volatility of the S&P 500 and NASDAQ.

You’ll see that by this measure, your account is likely exhibiting far less risk than both of the popular index benchmarks. This is done to make it possible for you to stick with investing regardless of what the market is doing. The major impediment to successful investing for most investors is their tendency to feel overconfident at market tops, causing them to overcommit to risky investments, and their overwhelming pessimism at market bottoms, which leads to abandonment.

Your benchmarks should reflect your goals

Benchmarking should be like a travel search for a summer getaway. If you are looking for a rustic cottage on a lake, you shouldn’t be searching under multi-faceted resorts. Your investing benchmark should be individualized to the goals you are trying to achieve.

Going “up north” is one of summer’s great pleasures, but knowing where north is relative to what counts is essential. After all, the Arctic Circle is north of everything. If you go, take snowshoes, not a bathing suit!