Why You Shouldn’t Compare Your Retirement to the S&P 500
Comparing your retirement investments to the S&P 500 can be misleading and may not reflect your true financial health
Retirement, Investments, S&P 500, Financial Planning, Canada
Toronto: You know how sometimes you get mixed up with temperatures? My husband, being Canadian, talks in Celsius. So when he says it’s 27 degrees, I’m thinking winter gear. Turns out, that’s actually 80 degrees Fahrenheit! It’s a classic case of misreading the data.
Finance can be just as tricky. A lot of folks love to measure their investments against the S&P 500. But when you’re retired, that comparison can be as misleading as my temperature confusion.
The S&P 500 uses time-weighted returns, which don’t consider cash flows like withdrawals. If you’re taking money out, you might feel like you’re falling behind when, in reality, your investments could be doing just fine.
What really matters is the internal rate of return (IRR). This shows the actual money you’re gaining or losing, taking into account your withdrawals. Sadly, many financial firms stick to the simpler time-weighted method, which can be misleading.
Plus, your investment mix probably doesn’t match the S&P 500. If you have a portfolio that’s 60% stocks and 40% bonds, and the S&P returns 10% while bonds earn 4%, your expected return is around 7.6% before fees. But we often get caught up in those flashy S&P returns and forget about our own unique situations.
Some people don’t even look at the S&P 500; they focus on a specific number they think they need to retire. This idea comes from Lee Eisenberg’s book, “The Number.” I’ve met many who believe they can’t retire until they hit that magic figure.
The issue? That number doesn’t consider time. Retirement planning is all about the time value of money. If you plan to retire at 55, your number might not cut it due to inflation. But if you wait until 75, you might have more than enough. Many end up working longer than necessary, thinking they need to reach that specific target.
A better way to track your progress is through a capital needs analysis. This method, often used by pension managers, looks at the present value of what you’ll need to cover future expenses.
For retirees, this means mapping out your cash flow needs over time. Unlike a pension’s steady payouts, your expenses can vary—think healthcare, home repairs, or even weddings. A capital needs analysis adjusts for these changes as they come up.
Another personalized approach is a method that measures your progress based on the assets needed to maintain your lifestyle throughout your life. This involves a detailed projection that includes savings, withdrawals, taxes, and those big expenses that pop up unexpectedly.
Let’s be real—creating a personalized benchmark is a lot of work. It’s way easier to just compare your returns to the S&P 500 or focus on a single wealth target. But as you move from growing your investments to relying on them, those broad measures might not be as helpful.
If you’re getting close to retirement, it’s time to rethink how you measure success. The benchmarks that worked for you while you were working might not fit your retirement goals. It’s not just about maximizing returns anymore; it’s about ensuring you have reliable cash flow for life. So, consider a more tailored approach that truly reflects your progress during this new phase.