While a dollar may not be worth as much as it used to be, you can still stretch a buck pretty far. With a dollar bill, you can buy yourself a candy bar, a postage stamp, or even a ribeye steak. Unfortunately, you may not be able to do so forever. Why? Because inflation exists!
It is because of inflation that candy bars and postage stamps cost more today than they did five years ago. You don’t need me to tell you that prices of food and other essentials haven’t stayed the same over the years. Candy bars once cost just a nickel, and postage used to cost just six cents. These are sad – but common – examples of inflation eating away at the value of your money.
Inflation Is All That Matters
Since inflation is so hurtful to your money, we need to keep a watchful eye on it. If we don’t, it will destroy our hard-earned wealth.
One easy way we can monitor inflation and how it affects our wealth is by comparing the growth of inflation to the growth of your money. This allows us to compare the real value of your money yesterday, today, and tomorrow. At Define Financial, we monitor inflation by using an inflation benchmark on all of our investment portfolio performance statements.
What’s a Benchmark?
A benchmark is a point of comparison. Using a benchmark gives us a frame of reference. This helps us evaluate the performance of our investments.
Consider a benchmark in your life — maybe one that you don’t even know is a benchmark. As an example, many people use their high school weight as a benchmark for what their weight should be today. If you weighed 150 pounds in high school, then you shouldn’t weigh any more than 150 pounds today.
Or maybe they’ll do the same with a certain pair of jeans. Not being able to fit into the pair of jeans is a benchmark for being out of shape. Once you can no longer squeeze into your jeans from high school, you know it’s time to re-evaluate your diet. Without that pair of jeans, we wouldn’t know we’re starting to get thick around the middle. Fitting into old jeans is our benchmark.
If you’ve ever received an account statement on the performance of your investments, you’ve likely seen an investing benchmark before. One very common benchmark is the Standard & Poor’s 500 Index. The S&P 500 contains a broad mix of U.S. stocks of large companies. Looking at the S&P 500 can tell you the investment performance of those 500 large U.S. companies. Of course, there are other benchmarks besides the S&P 500 that track the performance of various markets.
Using Investment Benchmarks Over Time
A long time ago, financial planning wasn’t a thing. The idea that you could plan out your life and optimize your finances to achieve your personal goals didn’t exist. In place of financial advisors, there were professionals known as “money managers” or “investment managers.” These people would take your money and, if they didn’t screw up too badly, turn it into even more money.
Of course, it’s difficult to measure whether an investment manager screws up or not without a point of comparison. Enter the benchmarks. Stock and bond benchmarks were used to judge the performance of an investment manager. Given that the focus was so narrow, using an investing benchmark (such as the S&P 500) made sense.
The other reason benchmarks were used is more complex. At the time that using benchmarks was first popularized, investment managers weren’t just trying to grow wealth to keep up with inflation and match the market. They touted their ability to “beat the market” or help you earn a better return than the masses were earning overall.
Of course, over time, it became evident that these investment managers could not beat the market. It was also determined that investment managers didn’t determine investor return as much as the cost of investing did.
As a result, savvy investors have largely moved into low-cost investments today. If you can match the benchmark and keep your investing costs extremely low, you can do well in today’s investing environment.
Investing Benchmarks Today
These days, personal finance has become much more sophisticated than investing alone. Instead of looking at just one piece of your life (your investments), financial planners are able to look at everything in your life that involves money. This includes aspects of your life such as:
- Risk management using insurance products
- Estate planning to make sure that your family is set up for success once you’re gone
- Retirement planning to ensure you can stop working if that’s what you want to do, or it’s what you have to do
- College planning
- Cash flow and expense tracking
- Debt management
As financial advisors have begun helping their clients manage more than their investments, the way that we look at investments has changed, too. Investing is no longer only about making the most money possible. Investing has become about having enough money so you can do what you want with your life.
Over the years, portfolio design has changed to reflect client goals more and more. It has become clear that investing is about meeting a client’s goals rather than beating some arbitrary benchmark.
Stock and Bond Benchmarks Don’t Make Sense
There’s not one single stock or bond benchmark, or even more exotic benchmark such as hedge fund performance, that you should be using. That’s because all these benchmarks do is measure the investment performance of an index. And, if you’re using low-cost investments (which you should be) that track the performance of a particular index (e.g., an S&P 500 index fund), then you are getting the return of that index anyway.
So, what benchmark should you be using if you’re not trying to beat the market? Inflation!
Inflation is all that matters. Since we’re using money to achieve our goals, we should be measuring how well our money can meet those goals over time – instead of how our investments are performing relative to some other measure.
Inflation as the Benchmark for Your Investments, and Your Life
Use inflation as your point of comparison when you look at your investments. That’s because the S&P 500 (or any other investment benchmark) has little to do with how you are going to be able to achieve retirement, nor can it tell you if you’re on track to accomplish what you want in life.
Your money may be worth less in the future than it is today. But, you can use that knowledge to your advantage. By keeping track of inflation with respect to your investments, you can make sure you’ll have the cash you need to reach your lifestyle goals in retirement.