SOME FRIENDS WERE recently discussing their investment performance. I couldn’t contribute to the conversation—because I have no idea what our investment returns have been.
The fact is, I don’t find performance information all that valuable, plus it’s relatively hard to calculate since you have to account for both price changes and dividend or interest payments. To be sure, investment returns are useful if you’re looking to determine whether a mutual fund manager is adding returns in excess of a benchmark index, also known as generating alpha. But since I invest mainly in index mutual funds and exchange-traded index funds, I’m not expecting to achieve any alpha.
Moreover, folks don’t spend investment returns. Instead, what they spend are dollars. I can have terrific returns, but if I don’t have much invested, it won’t amount to much.
So how do I track our financial progress? Every year, I calculate the net worth—all financial accounts minus all debt—for my wife and me. I then take that figure, and look at measures that assess net worth or total savings as a multiple of your salary. Different financial firms have slightly different guidelines.
For instance, as you can see from the accompanying chart, T. Rowe Price says that 45-year-olds should have financial assets that are two to four times their annual salary. Savings benchmarks are also available from Fidelity Investments and in Charles Farrell’s book Your Money Ratios.
The idea behind these measures: Your net worth or total savings should hit the various age milestones—and, if it does, you’re on track to retire in comfort in your 60s. HumbleDollar’s Two-Minute Checkup uses a similar methodology to assess a user’s “financial fitness.” Even though I have no idea what our investment returns have been, I can track our net worth as a multiple of our salaries, and that tells me we’re in good shape for retirement.
As it happens, fluctuations in our net worth these days often closely mirror fluctuations in the S&P 500. But it hasn’t always been that way. For instance, in three out of five years in the late 1980s, our net worth went up at least twice as much as the S&P 500’s return. While I’d like to claim these results were driven by my investment savvy, the truth is that we were young and had few assets. The amount we contributed every year to our 401(k)s and IRAs represented significant additions to our net worth. Those contributions, plus our investment returns, turbo-charged the increase in our net worth.
At times, we’ve also significantly underperformed the S&P 500. In 2018, we had losses that were twice as large as those of the S&P 500. When the market recovered in 2019, we pocketed half the market’s gain.
What led to such significant underperformance? Part of my compensation took the form of stock options. Since options are only worth exercising when the share price is above the strike price, their value can be highly volatile—and both 2018 and 2019 were rough years for my stock options. On top of that, our portfolio includes a significant stake in foreign stocks and it has a value tilt. Both trailed the S&P 500 over the past decade. Still, thanks to the chart, I knew we were still on track for retirement.
