The most important index you should track

Everyone wants to beat the market on the way up, but no one wants to ride it on the way down. It's human nature to want all of the reward without any of the risk, but unfortunately this investment doesn't exist. For most investors with a the long-term time horizon, the returns they can achieve by just owning "the market" through an index fund or similar investment, is usually a suitable choice.

But, can you stomach the market volatility?

What happens when we are faced with huge swings (both up and down) and now you simply own the market? It is during these times of extreme volatility that it is important to really hone in on what index you need to achieve your goals versus some arbitrary group of investments that may not be suitable for you.

When building a financial plan for my clients, it is at this point that we also build their index. Mr & Mrs Smith track "The Smith Index", while the Hendersons track "The Henderson Index," and so on. By establishing YOUR personalized index, there is less stress when every news outlet is shouting about Bear Markets and double-digit drawdowns. It also allows clients to not worry about how every single index is performing (or under-performing). We have seen tremendous performance differences so far in 2022 where the tech-heavy NASDAQ has taken the brunt of the losses, while some of the broader indices have been more stable.

How do you build your own index?

The first thing you should do is establish your goals. These usually involve a few major milestones such as private school, college tuition, a second home purchase, & retirement. From there, we add in some other major expenses: new car(s), travel, wedding, & charitable giving. The first group are what we call "needs", the second are "wants or wishes." All are equally important until we need to figure out how to pay for them; then it's time to make some hard decisions on what is really important.

Each goal usually takes place at a specific time in one's lifetime, so now we start inserting the goals and their cost accordingly. The further out the goal, the lower return we usually have to achieve to get there, so we can take far less risk. However, some goals are a one time cost (wedding) vs an annual occurrence (retirement). Ultimately we come up with a rate of return needed to grow current & future assets to hit these goals at different points in time and for a specific time frame.

This rate of return takes into consideration many factors, but primarily it is how much upside risk can we take without losing too much on the downside. (Remember, for every percent move down, you have to earn back twice as much to break even). Taking less risk for our clients allows them to feel comfortable during market volatility and doesn't force us to become short-term traders to attempt to hit goals.

Your index vs "the market"

Once we figure out that rate-of-return, we have YOUR personalized index. We now construct all investment decisions around that number rather than trying to beat a general market index or return. Because of the type of clients we work with, we are usually looking at a return that is mid to high single digits...after fees and taxes. Historically, this allows us to build a balanced portfolio of stocks, bonds, alternatives, and cash rather than owing a 100% equity portfolio heavily weighted in aggressive stocks.

This personalized index is now the benchmark that we base all asset allocation decisions for each client rather than just trying to "beat the market." Because we are taking on less risk than the markets, it's reassuring for clients (and us) to be able to open their statement with a sigh of relief especially when the "market pundits" on TV are nothing but negative. Next time you open your favorite market app, and the headline reads "Markets are DOWN;" ask yourself: do I really own "the market" and how is MY Index performing?

-Jason

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