Editor’s note: A version of this post previously ran in 2015. We believe it’s an important topic for advisors and is worth revisiting. The data contained in the chart have also been updated.


A formal investment plan or an investment policy statement (IPS) offers a blueprint for financial success. But how should success be measured? Too often, clients compare the performance of their portfolios with a curious mix of reference points, often to their (and their advisors’) detriment. Ever hear something like this during a client meeting: The S&P 500 was up 10% last year, so why was my portfolio only up 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. Many clients seem to believe that the S&P 500 is a reasonable performance benchmark. After all, it is 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’s 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.


Desired versus required returns

A client’s 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 on factors or influences specific to the client’s stated objectives and constraints. These external influences are ever present, from the media and the blogosphere to your clients’ own experiences. From 1926 to 2016, the average annual return for U.S. stocks was 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.


Returns are almost never average

Annual stock and bond returns, 1926–2016

Annual stock and bond returns: 1926-2016

Notes: Represents each calendar year from 1926 to 2016 (91 points = 91 years) plotted at the intersection of that year’s stock return and that year’s bond return. The vertical shaded area contains all years whose stock return was between 8% and 12%. The horizontal shaded area contains all years whose bond return was between 3% and 7%. Stock returns are represented by the Standard & Poor’s 90 Index from 1926 through March 3, 1957; the S&P 500 Index from March 4, 1957, through 1974; the Dow Jones 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. Bond returns are represented by the S&P High Grade Corporate Index from 1926 to 1968, the Citigroup High Grade Index from 1969 to 1972, the Lehman Brothers U.S. Long Credit AA Index from 1973 to 1975, the Bloomberg Barclays U.S. Aggregate Bond Index from 1976 to 2009, and the Bloomberg Barclays U.S. Aggregate Float Adjusted Index thereafter.


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

The required return is essentially the average return necessary to meet the objectives that your clients said were most important to them. It’s a vital part of developing an asset allocation that balances the risk tolerance and return objectives. For many clients, their required return is often far more modest than a 9% or 10% desired return, which is good news, since many clients would likely have a hard time enduring the volatility of an all-stock portfolio.


Making investment progress personal

Serving as your clients’ ongoing measure of progress, the required return can have a twofold benefit. First, it is based solely on the IPS, which is specific to your client, rather than on external factors that are more often distracting, rather than useful. Second, it supports the asset allocation process, which fosters portfolios that are more balanced and intended to moderate both risk and volatility. In my experience, the majority of investors 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 clients 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 clients 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.

Look for my next blog post, in which I’ll discuss the what, why, and how of setting a course toward your clients’ required return.



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 nearly 3,600 companies as of June 30, 2017.

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 used the S&P 90 Index from 1926 through March 3, 1957; the S&P 500 Index from March 4, 1957, through 1974; the Dow Jones 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.