Financial Benchmarks Investors Should Consider To Gauge Performance

Financial Benchmarks Investors Should Consider To Gauge Performance

Without proper financial benchmarks, you don’t know whether you are getting ahead, staying in place, or getting left behind. Therefore, it’s important to choose at least one financial benchmark on your journey to riches.

There is one consistent observation I’ve noticed in my journey towards financial freedom. Rich people make things more expensive for the rest of us. Given the supply of desirable necessities such as homes, schools, food, and even water is finite, the rich bid up prices far beyond what the middle class can afford.

Inflation Is A Silent Financial Benchmark

The one financial benchmark we should at least keep track of is inflation. If we are not at least beating inflation, we are losing.

I remember back in 1995 thinking $20,000 to go to a private university was ridiculous. Now such a private university costs $50,000 in tuition. Ridiculous again, especially with the internet providing so much free education now.

Did the median salary increase by 125% in the past 25 years? Unfortunately, no. The median wage actually fell 8.9% from its peak in 1999 to around $50,000 per household in 2012. Only until 2016, or 17 years later, did the real median household income get back to where it was in 1999.

I remember wanting to buy a sweet two bedroom, two bathroom, double balcony condo in Manhattan with a view of the Chrysler Building and Madison Square Park for $790,000 in 2000.

The problem was I was too poor at the time with just one year of post-college saving and investing under my belt. Even with some folks leaving Manhattan, the cost of the 1,350 square foot condo is now roughly $2 million dollars sadly enough.

As my portfolio grew over time, I became much more risk averse with my investments. With the Asian financial crisis in 1997, the Russian Ruble collapse in 1998, the stock market implosion in 2000, the mortgage market meltdown in 2008, and the “flash crash” in March 2021, it’s hard not to be more protective of my nest egg.

However, in order to not fall behind, I used various financial benchmarks as a sort of coach to keep me going. Let’s look at what they are.

Financial Benchmarks To Help You Grow Your Wealth

Your ultimate goal is to grow your net worth large enough so that it can generate enough passive income to cover your desired living expenses. Therefore, you should aim to grow your overall net worth, not just your investments.

The S&P 500 Index

The easiest and most common benchmark if you live in America is comparing your portfolio’s return with the 500 largest stocks in the country.

One way to outperform the S&P 500 index benchmark is to invest all you net worth into the S&P 500 and save. Due to your savings, your net worth will always outperform the S&P 500. However, most people have a more diversified net worth than having 100% in the S&P 500 index.

I run my net worth like a multi-strategy fund comprised of real estate, equities, bonds, private equity, and a business. Given stocks have returned roughly 10% a year, including dividends, since 1926, I have a goal of growing my net worth by 10% a year as well.

Risk-Free Rate Of Return Times A Multiple

The risk-free rate of return is the 10-year bond yield which changes every single day. You need to figure out a reasonable multiple on that bond yield because you are guaranteed to return the yield if you put all your money into treasuries.

What rate of return over the risk free rate (equity risk premium) do you require? My simple formula is to take the latest 10-year bond yield and multiply the figure by 3. Back in the good old days, when the 10-year bond yield was at 4%, I would shoot for a ~12% investment and annual net worth return.

Today, with the 10-year bond yield under 1%, if you want to follow this benchmark, adjusting your investment target down to just 2.5% – 3% may be appropriate. In other words, when everything is expensive, you may want to lower your risk exposure to protect your gains.

I like this particular financial benchmark because it allows you to adjust with the times. As we’ve seen from a previous article about a proper withdrawal rate, many people are inflexible with their beliefs or investing decisions. Be like water.

Sector Specific Exchange Traded Funds (ETFs)

If you work in the real estate industry, then perhaps you should consider benchmarking your financial performance to a homebuilder ETF such as ITB, XHB, or PKB.

If you work in pharmaceuticals, then consider ETFs such as PJP, IHE, XPH. Or maybe you work in finance like I did for 13 years. Then maybe indexing yourself against XLF is a good idea. Whatever industry you are in, there is an index or an ETF for you to use.

Given I live in San Francisco, I like to sometimes benchmark my net worth performance to the tech-heavy NASDAQ. However, this is not necessarily fair since I don’t have a tech job.

Consumer Price Index

The CPI is produced by the Bureau of Labor statistics and is often maligned as an unrealistic gauge of inflation. For example, the current CPI is roughly 1%. With university tuition still going up ~4% during a pandemic and food prices showing no signs of abating, it’s hard to believe the official CPI numbers. The CPI should be considered the base case benchmark for everyone to beat.

The S&P/Case-Schiller Home Price Index

The Case/Schiller Home Price Index has risen to be the authoritative benchmark for real estate performance. The Index breaks down home price growth by region.

Given we’ve discovered that a lion’s share of the median net worth in America consists of property, then the Case/Schiller Index should be a relative good barometer for the median American.

S&P/Case-Shiller Home Price Index

Hedge Fund Index

Hedge fund managers are supposed to be masters of the universe. Unfortunately, they suck a lot of wind in a bull market by nature of their mandate to hedge. They have absolute return goals where investors expect them to continuously make money even during recessions.

One of the most widely followed hedge fund ETFs is HDG. The HDG is designed to reflect hedge fund industry performance through an equally weighted composite of over 2000 constituent funds.

Alternative Financial Benchmarks

Now that we’ve gotten some official financial benchmarks out of the way, let’s look at some alternative financial benchmarks to follow.

Your Parents Net Worth At A Certain Age

Ask your parents what their net worth was at your current age or at an age where you want to achieve a particular milestone.

You’ll have to then adjust their value in today’s dollars to make the comparison more true. By a certain age, did your parents own a home? What was their student loan amount at 25? Where were they in their careers at age 30?

Our elders are the greatest source of wisdom. It’s always interesting to learn lessons from our parents so we can avoid mistakes they may have made.

Your Friends

Comparing your financial progress to a friend can be tricky. It can lead to jealousy. But it is one of the easiest way to see how you’re doing. Further, if you can’t be truly happy for your friend’s success, perhaps you are not really friends.

One good benchmark is to compare how you’re doing compared to the valedictorian or salutatorian of your high school or college class. If you’re crushing them, you should feel great! If not, it’s OK because they are supposed to be doing well.

See if the average net worth of five peers comes close to equaling your own. You’ll have to make some guesstimates based on their visible assets in this terrific world of stealth wealth.

The 1/10th Rule For Car Buying

You can use specific buying rules to help motivate you to make more and build more wealth. On such rule is the 1/10th rule, which states that the car you want to buy should be no more than 1/10th your gross annual income.

Hence, if you see a colleague buy a $30,000 car, assume that s/he rationally makes $300,000 a year. Even though there’s a high chance your colleague does not make 10X more than the value of the car s/he purchased, you can use the rule as a motivator to earn that amount of income.

Not only do you gain income motivation, you also end up being disciplined financially when it comes time to buy a car. A double win.

The 30/30/3 Rule For Home Buying

One part of my 30/30/3 rule states you should limit your house purchase to 3X your annual gross income. Therefore, if you see someone buy a $600,000 house, then your goal should be to make $200,000. If you see someone buy a $3 million house, you goal should be to make $1 million, if that someone is a peer you respect.

Whether someone follows my 30/30/3 home buying rule is a different story. They may have received helped from the Bank of Mom & Dad or spent 7X their annual gross income on a house. You don’t know for sure.

The goal is to trick yourself into following this benchmark to earn more money and build wealth. The 30/30/3 rule allows you to gauge your income and asset accumulation progress.

Free Time

Freedom is the most important reward for having money. Although one of my friends is relatively poor, I consider him one of the richest people I know because he plays tennis three hours every day. If you get to do what you love every day and not have to work too much for money, you are in the top tier of wealth.

Financial Benchmarks Investors Should Consider To Gauge Performance

It’s hard to assign a specific value or scale to the Freedom Factor benchmark. However, you can quantify freedom into the number of hours you get to be free in a 24-hour period.

If you have to work 10 hours a day, you have 14 hours of freedom. 14 hours is likely the average amount of freedom an average person has. For every one more hour of freedom you get, perhaps that’s equivalent to a 10% greater net worth.

Once you achieve 24 hours of freedom every day, you may be equivalent to the richest people on Earth. However, even multi-billionaires like Jeff Bezos don’t have 24 hours of freedom a day. Therefore, are you truly rich if you don’t have 100% control over your time? Something to ponder.

Life Expectancy

Perhaps there is no greater financial benchmark than life expectancy. You can be a billionaire, but if you are unhealthy and die at 50, that’s no good. I’m pretty sure most of us would choose to have average wealth and live a healthy life until age 100.

Although we cannot guarantee ourselves a long and healthy life, we can do things to improve our chances. Therefore, we should eat well, exercise regularly, and take care of our mental health. These activities are especially important during a pandemic.

I’ve found that limiting news and social media consumption helps my mental health. I also try and focus on the positives every day. Let us regularly count our blessings. Please do not waste time! Do not put off the things you truly want to do or see.

When the world opens back up, I’m expecting millions of us to finally get busy living. The amount of travel and spending is going to be enormous!

Historical life expectancy in America
Source: Worldometers

Make Sure You’re Heading In The Right Direction

Whatever benchmark you use to gauge your financial performance, make sure it helps you boost your wealth. Although my base case financial benchmark is 3X the risk-free rate, my aspirational benchmark is to have my overall net worth beat the S&P 500’s performance each year.

Figuring out where you stand is a timeless pursuit. It’s the reason why posts such as The Average Net Worth For The Above Average Person, 401k Amounts By Age, and Target Net Worth Levels By Experience continue to be so popular.

But once you know where you stand, practice living your best life. The financial benchmark of free time is really the one benchmark we should all shoot for.

Readers, what are some financial benchmarks you use to gauge your financial performance? What is your favorite financial benchmark to follow in this time period?

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