How Do Your Clients Measure Financial Success?

By financial success, you’re probably thinking investment performance. But what I really mean is:

How do you measure whether you are on track to meet your financial goals?

Surely that is what matters.

More often than not, financial advice is focused on coming up with the “best” investment portfolio. And subsequently measuring how that portfolio did with respect to some benchmark, like the overall stock market for example. Or worse, comparing your results with someone at the dinner party.

Most people invest savings generated over a lifetime of work so that it’s available to spend at some future date — on goals like retirement living, travel and/or kids’ college education, amongst others.

In which case, how much does your investment portfolios’ performance over the last few months, or a year, tell you about whether or not you’re on track to achieve your financial goals?

It’s akin to dieting and exercise. You can measure how many fewer calories you took in today, or count the number of steps. You can compare it to the previous day, week, month, etc or even with a co-worker or spouse. Yet ultimately you want to measure the impact on your health. Say your weight, cholesterol, etc.

Last year was rough for those invested in the stock market. US stocks lost -4.4%, while a basket of global stocks* saw a loss of -8.7%.

The real question is how much did it matter? Did 2018 really throw you off track from meeting your financial goals?

Let me illustrate with an example, or rather, two. First, we go back to 2017.

Diane and Jack

Consider two individuals: Diane is 35 and Jack is 60. Both want to retire when they are 65, which means Diane has 30 years to go while Jack has 5 years.

When 2017 ended, Diane had a retirement account balance of $120,000 while Jack had built up a nest egg of $920,000. Both intend to invest $12,000 in every remaining working year until retirement.

Now each of them needs $1 million at the beginning of retirement to fund all their goals. I am going to ignore inflation to keep things simple (but read my previous piece on why accounting for inflation is important ).

Diane and Jacks’ retirement portfolios are invested in a basket of global stocks, with an average expected return of 7% per year. However, there is considerable variability around this, or risk (in investment management jargon). For example, the annual portfolio returns could look like this:

18%, 7%, -25%, 30%, 15%, 6% and so on ….

It may eventually average out to 7% a year, but that does not mean the portfolio return is exactly 7% each and every year .

A portfolio of global stocks had an average annual return** of almost 7% over the 15-year period leading up to 2018. Yet there was considerable variability in annual returns. The highest was 33% (in 2009) and the worst year was 2008 when the portfolio lost almost -41%. The variability or standard deviation for those familiar with statistics, of this portfolio of global stocks was almost 15% per year. Which is the number I’ll use in my current example?

The issue with return variability is that we cannot get a precise answer as to how much the nest egg will be worth at retirement. We can only come up with a probabilistic estimate. As I discussed in my previous piece, the problem is that a particular sequence of returns may look like

18%, 7%, -25%, 30%, 15%, 0% and so on ….,

while another could be

20%, -18%, 7%, 0%, 4%, 10% , etc.

So we use computer simulations*** to come up with 10,000 of these sequences. Then we count the number of successful sequences — those in which the portfolio grew to at least $1 million. That gives us a “ success probability ”, i.e. the number of successful sequences divided by 10,000.

For both Diane and Jack, given their current portfolio size and savings rate, the simulations indicate they have an 80% chance of hitting the $1 million mark at retirement. Which is in the middle of the “ comfort zone ”: 70% to 90%.

A rough market changes the odds, but how much

Now fast forward a year. A basket of global stocks fell -8.70% in 2018. As a result:

Diane (who is now 36) saw her retirement portfolio fall from $120,000 to $109,560. Though she did make it up with her annual contribution of $12,000, which brought her retirement account up to $121,560.

Jack (now 61) saw his retirement account fall from $920,000 to $839,960. His annual contribution of $12,000 brought the balance to $851,960, but it’s hard enough to fill the gap.

So how far off track did 2018’s poor returns send them?

I ran the simulations again — this time calculating the odds of Diane and Jack growing their nest egg to $1 million in 29 and 4 years, respectively (since we moved ahead a year).

As the chart illustrates, Diane’s odds don’t change too significantly. It falls to 77% but remains in the comfort zone.

At the same time, Jack’s odds of hitting his retirement goal have collapsed to 66%. That’s because he has only two more years to go.

This does raise the question as to whether Jack should’ve been in an aggressive portfolio of just stocks this close to retirement?

Improving Jack’s odds

Let’s make a slight change to Jack’s scenario and assume his retirement savings were invested in a 50/50 stock/bond portfolio across 2018. In this case, the bond piece provided some protection, and the portfolio lost -4.2% (compared to -8.7% for a portfolio of just stocks).

As a result, Jack’s retirement portfolio balance would have been $893,452 at the end of 2018. Which is better than the $851,960 figure we saw above.

So what happens to the odds?

It still falls, but to about 73% as opposed to 66%.

Jack could even stretch a bit and raise his savings over the next four years to increase his odds of hitting the $1 million mark at retirement. The hole that he has to dig out of is much smaller.

Staying on track

Of course, Diane and Jack’s situation is complete fiction but my goal is to illustrate an important point.

Reviewing portfolio performance is important but at the end of the day, what you really want to know is whether or not you’re on track to meeting all your financial goals.

If poor market performance throws you significantly off track (like lowering the odds of meeting your goals by 10–15 percent), you need to ask yourself, or your advisor, what went wrong. Just as important, what needs to be done to get back on track, and executing.


*US stocks proxied by the S&P 500 index.Global stock portfolio: 55% in the S&P 500 index, 35% in the MSCI EAFE index (net), 10% in the MSCI Emerging Markets index (net).50/50 portfolio: 27.5% in the S&P 500 index, 17.5% in the MSCI EAFE index (net), 5% in the MSCI Emerging Markets index (net), 50% in the Bloomberg Barclays US Aggregate index.Portfolios are rebalanced monthly between January 2004 and December 2018.Returns data relies on hypothetical indices and is exclusive of all fees and expenses. Returns assume the reinvestment of all dividends. It is not possible to invest in an index and past performance does not guarantee future results.**Average return refers to the compounded annual geometric average return and NOT simple arithmetic average return.***Portfolio Visualizer was used for all the simulations in this piece. Taxes, transaction costs and other fees are not taken into account.