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Benchmarking With Apples And Oranges
If we ’ re benchmarking our clients ’ portfolios , the benchmarks should look like their actual portfolios .
By Craig L . Israelsen
HOW IS THE PERFORMANCE OF A broadly diversified portfolio properly evaluated ? Against the S & P 500 ? That truly makes no sense . That would be analogous to comparing a tomato to salsa . Tomatoes are in salsa , but so are a lot of other ingredients . Diversified portfolios likely include a fund that is comparable to the S & P 500 , but also should include a host of other asset classes — such as small-cap stocks , non-U . S . stocks , real estate , bonds , etc .
If an advisor builds an aggressive portfolio ( hot salsa ) for a client , what performance benchmark should be used to evaluate the performance ( both volatility and return ) for that specific portfolio ? The S & P 500 ? Ninety-day T-bills ? A 60 / 40 portfolio ? Wouldn ’ t the most logical benchmark be a similar portfolio with a comparable asset allocation ? Or , to continue the salsa metaphor , should we say the benchmark for hot salsa is another brand of hot salsa — not a mild salsa .
This article presents six asset allocation models ( six different salsa recipes ) over the past 50 years ( from 1973 to 2022 ) that might reasonably serve as logical benchmarks for different portfolios built for clients . The six portfolio models range from 100 % equity to 100 % fixed income . Six well-known indexes were used to build the portfolio models : the S & P 500 , the Russell 2000 , the MSCI EAFE , the Dow Jones U . S . Select REIT index , the Bloomberg U . S . Aggregate Bond Index and 90-day Treasury bills . Indexes are not investable , but there is no shortage of ETFs and mutual funds that replicate them . And of course , actual investable products have expense ratios , whereas indexes do not .
One of the allocations we tested is an all-equity portfolio that has a 40 % allocation to the S & P 500 , while the Russell 2000 , MSCI EAFE and the Dow Jones REIT each get 20 %. These allocations were maintained by annual rebalancing . Taxes and inflation were not accounted for . In this model , the 50-year average annualized gross total return was 10.48 % ( when we assume there was a lump sum starting investment ) and the standard deviation of annual returns was 16.68 %.
This aggressive portfolio produced positive annual nominal ( meaning not inflation-adjusted ) returns 80 % of the time . In other words , over this 50-year period , there were 10 calendar years with a negative return .
Real World Performance During Retirement Now let ’ s consider how a retiree would have fared with this 100 % equity portfolio over 25 years of retirement . Let ’ s assume the retiree starts with a balance of $ 1 million and takes annual withdrawals at the end of the year determined by the required minimum distribution rules when he or she turns 72 . Using the current RMD guidelines ( before the SECURE Act 2.0 ), the first-year withdrawal would be 3.65 % of the portfolio ’ s ending balance . The next withdrawal would be 3.77 %,
MARCH 2023 | FINANCIAL ADVISOR MAGAZINE | 41