From the Expert: Hitting the benchmark just isn't acceptable

December 5, 2007

It's not good enough for your investment portfolio to do only as well?no better, no worse?than the overall market. Here's why you should aim higher.

It's not good enough for your investment portfolio to do only as well as the overall market—no better, no worse. Here's why you should aim higher.

Say you invested $100,000 in an S&P 500 Index fund from March 2000, when the index hit a record high—and a three-year bear market began—to May 2007, the so-called breakeven date, when it finally closed at that prior record high. If you reinvested your dividends, you'd now have $126,000 in your account. (If you didn't reinvest your dividends, you'd end up with the same $100,000, and even less if you factor in the effects of inflation.) This doesn't seem like much of an achievement when you consider that an investment earning a modest 5 percent annualized return over seven years would result in an account worth about $142,000 today.

Even worse, the bond market had great returns during this period of time. The $100,000 investment could have earned an annualized return of 6.3 percent in bonds, as measured by the Lehman Brothers Aggregate Bond Index, making it now worth more than $155,000. (Don't get me wrong, I'm not advocating investing in just one asset class, a risky proposition.)

Had you divided the $100,000 investment among stocks, bonds, and cash in a moderately aggressive portfolio using the Vanguard 500 Index Fund (60 percent), Vanguard Lehman Brothers Aggregate Fund (35 percent), and Vanguard Money Market Fund (5 percent) during this period, the portfolio would have returned 4.3 percent annually and would now be worth about $136,000. It would have achieved this result with much lower risk than an all-stock portfolio, and higher potential than an all-bond portfolio.

The moral of this story: Don't invest all your money in one asset class or one basket of stocks—even if it's the S&P 500. Be smart and allocate your portfolio among stocks, bonds, and cash equivalents, and make sure you reinvest your dividends.

The author is a fee-only certified financial planner (CFP) with R.W. Rogé & Co. (www.rwroge.com) in Bohemia, NY. His firm provides comprehensive fee-only financial planning and wealth management services. The views expressed are those of the individual contributor and do not necessarily reflect those of Medical Economics magazine.