In an earlier blog, I wrote about the importance of having a formal investment plan or investment policy statement (IPS) and its role as a blueprint for financial success. But how should success be measured? Too often, clients compare the relative performance of their portfolios to a curious mix of reference points, often to their (and their advisors’) detriment. Ever hear something like this during a meeting with a client: The S&P 500 was up 10% last year, so why was my portfolio up only 6%? Frustrating, right? While we know the easy answer is that the client’s portfolio isn’t the S&P 500 Index, the question does raise a potentially more challenging point. What should clients use as a benchmark for success?

Let’s first understand the nature of the predicament. Clients seem to believe that the S&P 500 is a reasonable performance benchmark. In some ways, we need to sympathize with them because the S&P 500 is probably the most widely discussed proxy for U.S. stocks and stock market returns.¹ So when they look at the performance of their portfolios and wonder how they’re doing, it may be understandable that the return of the S&P 500 comes to mind. However, while this index is one benchmark for returns, it is certainly not the right one for typical clients, whose portfolios tend to be fairly diversified between stocks and bonds.

Their choice of the S&P 500 is an example of a desired return; that is, a return objective or benchmark that has been selected based on external factors or influences, rather than those specific to clients’ stated objectives and constraints. These external influences are ever-present, from the media and the blogosphere to clients’ own experiences. Since 1926, the average annual return for U.S. stocks has been a little more than 10%, and this seems to be pretty common knowledge for even neophyte investors.² So 10% would seem to be a reasonable expectation for an average year, right? Our illustration below shows how often that assumption is erroneous, but it is also irrelevant.

The benchmark for clients’ progress toward their goals should be their required return, which is a key output of their IPS. During the planning process, advisors consider their clients’ financial needs and aspirations; their risk tolerance and tax circumstances; their current and expected assets and liabilities; and expected capital contributions or savings, among other things.

The required return is essentially the average return necessary to meet the objectives that clients said were most important to them and can help in developing an asset allocation that balances the risk tolerance and return objectives. For many, if not most, clients, their required return is often far more modest than a 9–10% desired return, which is good news, since many clients would likely have a hard time enduring the volatility that can accompany an all-stock portfolio.

The required return can and should serve as clients’ ongoing measure of progress, which can have a twofold benefit. First, it is based solely on the IPS, which is specific to a client, rather than on externalities that are more often distracting than useful. Second, it supports the asset allocation process, which tends to result in portfolios that are more balanced and intended to moderate both risk and volatility. In my experience, the majority of investors tend to have portfolios more balanced between stocks and bonds, so a performance comparison with an all-stock index (such as the S&P 500) is bound to disappoint.

Helping investors understand why the required return—rather than a desired return—should be their benchmark for tracking progress toward their goals can benefit advisors and clients alike. For advisors, the required return provides a useful tool to help investors understand why the performance of any other benchmark is both impersonal and largely irrelevant. For clients, the required return is tailored to their goals, aspirations, and circumstances by an advisor who knows and understands them. It is their “mile marker” to progressing toward their personal goals and, once understood, may help clients stay invested for the long haul.


1 In our view, a more complete representation of the U.S. publicly traded stock market would be an index such as the CRSP US Total Market Index, which included more than 3,700 companies as of April 30, 2015.

2 When determining which index to use and for what period, we selected the index that we deemed to be a fair representation of the characteristics of the referenced market, given the information currently available. For U.S. stock market returns, we use the Standard & Poor’s 90 from 1926 through March 3, 1957, the Standard & Poor’s 500 Index from March 4, 1957 through 1974, the Wilshire 5000 Index from 1975 through April 22, 2005, the MSCI US Broad Market Index from April 23, 2005 through June 2, 2013, and the CRSP US Total Market Index thereafter.


Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Please remember that all investments involve some risk. Be aware that fluctuations in the financial markets and other factors may cause declines in the value of your account. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.