Escaping the Benchmark Trap: A Guide for Growing Your Wealth

At a glance: 

• The main takeaway: We believe individual investors who have become benchmark-focused may be harming their financial futures. To escape benchmark-focused investing requires a mindset shift towards target-oriented strategies with long-term financial objectives. 
• Impact on financials: Benchmark chasing can lead to an emphasis on short-term outlooks, over-trading, and underperformance that hinders the ability to achieve personal financial goals.
• Next steps: Shifting away from the benchmark-focused mindset and towards achieving your financial objectives. Financial planning can help you define your personal success and create a target-oriented approach that prioritizes your specific financial goals.

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The full story:

“Habit 2: Begin with the end in mind.”

– Stephen Covey, famed efficiency expert, from The 7 Habits of Highly Effective People

Many investors get caught up in the allure of chasing well-known benchmarks, like the S&P 500. While these benchmarks offer a general reference point, a relentless focus on them can hinder the ability to achieve personal financial goals.

At Aprio Wealth Management, we believe Stephen Covey’s principle of “begin with the end in mind” applies perfectly to investing. Instead of chasing benchmarks, we advocate for a target-oriented approach that prioritizes your specific needs and aspirations.

Five traps of benchmark chasing

• The Pitfalls of Benchmark Obsession: The allure of benchmark returns often overshadows the more crucial question— What target returns are needed to achieve our financial goals?
  
  The obsession with benchmark performance has led many investors astray, fostering a culture of underperformance. However, breaking free from this tyranny requires a mindset shift toward focusing on long-term investment objectives and the strategies necessary to surpass them.

• Misalignment with Financial Goals: Relying solely on benchmark returns can lead investors away from their true financial objectives. While benchmarks provide a useful reference, they may not reflect individual needs, risk tolerances, or timelines. Investors often misapply benchmarks relative to their goals, such as using the Dow Jones Industrial Average or the S&P 500 (both of which track the stock performance of large, U.S.-domiciled companies) for measuring performance of a globally diversified, multi-asset class portfolio.
  
  The core issue is that fixating on beating a benchmark, like the S&P 500, rarely has anything to do with an investor’s actual financial situation or needs. For example, a retired teacher living off their portfolio has vastly different investment objectives than a young tech worker or physician amassing a nest egg. Holding both to the same arbitrary benchmark makes little sense. Their unique goals should dictate their investment approach, not an irrelevant performance metric.
  
  For institutional investors, such as pension funds, endowments, and sovereign wealth funds, benchmarking can play a more relevant role. However, these entities have distinct requirements, constraints, and tax situations. They may measure themselves against benchmarks representing their asset allocation models and invest in asset classes without perfect passive index vehicles.

• Short-Term Focus: Benchmark fixation often promotes short-term thinking, encouraging investors to chase immediate gains rather than patiently building wealth over time. This mentality can result in impulsive decision-making and missed opportunities for long-term growth.

• Over-Trading: Constantly comparing performance to benchmarks can drive investors to engage in excessive trading, leading to higher transaction costs, higher taxes, and ultimately, diminished returns. Academic research has highlighted the negative correlation between over-trading and performance by individual investors.[1] Over-trading erodes the value of compounding and disrupts the power of patience in investing, while incurring higher transaction costs and taxes.

• Psychological Pressures: The relentless pursuit of benchmark beating returns can place immense psychological pressure on investors, fostering anxiety, fear of missing out (FOMO), and a propensity for irrational investment decisions. This emotional rollercoaster often leads to suboptimal outcomes.

Redefining success to focus on personal financial goals

To escape the benchmark trap, individual investors must redefine success in terms of their personal financial goals. Developing a financial plan is the first step. The result is a fundamental shift in mindset towards target-oriented strategies aligned with long-term financial objectives.

To do this, we believe in defining clear financial objectives, with an awareness of personal risk tolerances, and an understanding of the timing and the size of future cash availability needs (a.k.a. liquidity needs). Additionally, it is critical to consider factors such as inflation, taxes, gifting, and generational wealth transfer expectations. To accomplish this:

• Embrace the Marathon Mentality: Successful investing is a long-term game. By adopting this perspective, investors can tune out short-term market noise, avoid the emotional rollercoaster, and stay committed to their strategic goals. This mindset shift fosters discipline, patience, and resilience in the face of market fluctuations.

• Focus on Quality, Not Quantity, to Compound Wealth: Instead of chasing benchmark beating returns every quarter, prioritize investing in high quality investments with strong fundamentals and long-term growth potential. These investments can compound wealth over time, regardless of short-term market movements.

• Diversify and Rebalance: Building a well-diversified portfolio across different asset classes is crucial for managing risk and achieving desired returns. Periodic rebalancing helps to ensure portfolios align with overall strategy, even as market conditions change.

• Monitor and Adapt: Regularly review progress toward financial goals and adjust investment strategies as needed. Flexibility is essential for navigating changing market dynamics and adapting to evolving personal circumstances.

While we advocate for a target-oriented approach, benchmarks do have a place in our investment process, notably, to measure the performance of specific portfolio components, such as domestic equities or fixed income allocations. Benchmarks can be a helpful tool for identifying deviations from an investment thesis and understanding expected performance.

The bottom line

Escaping the serfdom of benchmark-focused investing requires a fundamental shift in mindset towards target-oriented strategies aligned with long-term financial objectives. By defining clear goals, calculating target returns, and embracing a patient, disciplined approach, investors can break free from the cycle of short-termism to achieve lasting wealth accumulation.

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Disclosures

Investment advisory services are offered by Aprio Wealth Management, LLC, a Securities and Exchange Commission Registered Investment Advisor. Opinions expressed are as of the publication date and subject to change without notice.  Aprio Wealth Management, LLC shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions contained herein or their use, which do not constitute investment advice, are provided as of the date written, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. This commentary is for informational purposes only and has not been tailored to suit any individual. References to specific securities or investment options should not be considered an offer to purchase or sell that specific investment.

This commentary contains certain forward-looking statements. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason.  No graph, chart, or formula in this presentation can be used in and of itself to determine which securities to buy or sell, when to buy or sell securities, whether to invest using this investment strategy, or whether to engage Aprio Wealth Management, LLC’s investment advisory services.

Investments in securities are subject to investment risk, including possible loss of principal. Prices of securities may fluctuate from time to time and may even become valueless. Any securities mentioned in this commentary are not FDIC-insured, may lose value, and are not guaranteed by a bank or other financial institution. Before making any investment decision, investors should read and consider all the relevant investment product information. Investors should seriously consider if the investment is suitable for them by referencing their own financial position, investment objectives, and risk profile before making any investment decision. There can be no assurance that any financial strategy will be successful.

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[1] Barber, Brad M. and Odean, Terrance, Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. Available at SSRN: https://ssrn.com/abstract=219228.