Why Benchmarking Is So Important

April 23, 2018

71 Shares

THIS POST MAY CONTAIN AFFILIATE LINKS. PLEASE READ MY DISCLOSURE FOR MORE INFO.

Recently, I’ve wondered why more financial advisors don’t benchmark.

I’ve talked to a few advisors, and some have confessed that they are reticent to create a benchmark for their clients. It’s just easier for them not to. It doesn’t help that most clients are unsure of what their money manager should be benchmarking against.

I was talking to a friend at work this past week. He was telling me about his deep affection for his financial advisor. My friend had gone through many bad advisors over his lifetime. He was overjoyed to finally have a good one.

I asked my friend how he concluded that his financial advisor was doing a good job. He said that his advisor was a straight shooter and told him that he would achieve average returns. My friend was ecstatic to have had his portfolio return 10% last year, when the historical average is 8%.

Sadly, I had to burst his bubble. I shared with him that the stock market returned 20% last year. He looked shocked. If market performance is “average”, it seemed clear that my friend was actually receiving below average returns.

Since his returns were much lower than the market’s, I was curious to know what his advisor considered “average”. Unfortunately, his advisor had never defined “average” for him. Instead, my friend simply trusted that “average” would be just fine.

I always say, nobody cares more about your money than you, except maybe the IRS. It’s imperative that you understand all of the money moves that your financial advisor makes. Unfortunately, advisors do not always have the best of intentions in terms of growing your money.

Expectations

The best way to avoid a sticky situation is by setting clear expectations ahead of time. “Average” returns is just too vague. Your advisor surely isn’t vague about his or her fee schedule.

Additionally, simply telling your financial advisor to maximize the amount of money that they can return for you is also not a wise goal. You also need someone who will guide you in the areas of estate planning, taxes, and even the psychological side of money. If the market drops by 50%, it’s important to have someone who will stop you from making a rash decision and assure you that the market will eventually get back up. It’s amazing how valuable level-headedness can be.

Quantify

You should be able to quantify your financial advisor’s performance each year.

For instance, if your financial advisor tells you that the S&P 500 will be the benchmark, you should expect that your return should match the S&P 500, including the financial advisors fees.

If they aren’t consistently matching whatever benchmark you set, should you really keep them around? On top of that, are they really earning their fee? Often times, that fee is 1% of the value of your portfolio.

With a $500,000 portfolio, the fee might be around $5,000 per year. You have to ask yourself, are you really receiving that much value? Even better, you’d hope that you are receiving more value than that.

No Benchmark

I find it truly comical when a financial advisor says that they don’t have a benchmark. Imagine if you could say that about your professional life as well. To me, this is really code for “don’t hold me accountable for my results, and if you’re content being oblivious, I’m happy taking a fee each quarter from you.”

At work, this would translate to, “Hey Boss, trust me that I’m doing a good job and just give me a paycheck. Don’t bother setting objectives on what I should achieve for the year because I’m doing just fine.”

This is laughable.

Understanding Your Portfolio

Hopefully by now, I have convinced you that a proper benchmark is key. Once you set a benchmark, it’s important to look into your portfolio to understand what exactly your advisor is doing.

Your portfolio may be a 60/40 split between stock and bonds. It may even be 100% in bonds. Either way, you need to know where and why your money is being invested. I’ll never forget meeting with an advisor to talk about a friend’s portfolio. I asked him why he had so many different holdings in gold, and he wasn’t able to give me a straight answer. When I broke down the information to my friend, he was baffled and pretty upset about the way his money had been invested. My friend had been clueless because he hadn’t taken the time to really dig in and figure out all of his holdings.

Stocks to Bonds Ratio

One of the easiest ways to see if your advisor is doing well is to figure out the ratio of your stocks to bonds. Then, utilize Vanguard Total Stock Market Index Fund and the Vanguard Total Bond Market Index Fund as your benchmarks. By using these two funds with the allocation splits that your financial advisor has set up, you should have a pretty good idea if they are earning their keep when it comes to investing.

If they’re not, while I can’t recommend specific funds, it may make sense to do some additional digging. You can even consider a robo advisor such as Wealthfront or Betterment. Either may be able to handle your money in a better manner than your financial advisor.

So readers, do you know how your portfolio compares to the market? Have you had to have a difficult conversation with a financial advisor? Share your thoughts below.