Make the Family Index your benchmark

It’s tough to compete on performance. When the stock market has a great year clients want the same, or better. They mention no-load index funds in every conversation. But when the market declines, they hold you responsible. “Yes, I like index funds, but I don’t like losing money,” they’ll say. What to do?

Family Index

I first heard about the family index from a Boston-area advisor. He separated want from need. The client wants to beat the averages. He needs a return that will achieve his desired goal within a specific timeframe.

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How does it work?

You and the client agree retirement’s the goal. He’s 35 years old and plans to retire at 65—a long time horizon. He has a pool of investable assets with you, plus a retirement account at work. He wants a certain lifestyle, and you put a price tag on it in today’s dollars and apply inflation. You project the asset total needed on his 65th birthday.

Setting the Family Index

Identify the rate of return needed to reach the target. Account for savings and retirement plan contributions. The math is similar to projecting mortgage payments. With mortgages you start with a debt, paying off principal monthly and interest along the way. The principal owed on the mortgage declines to zero.

With your client’s retirement goal you start with a low base of assets, assume a return on investment over time along with adding additional principal along the way, until the goal’s reached. In both cases you get a percentage number.

Explaining the rationale

You and the client now have a number they need to hit annually to achieve his goal. If the time horizon is long the number may be modest. Remember the “Rule of 72”? An interest rate divided into 72 approximates the number of years it takes to double the money.

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Let’s assume the client has $250,000 and his goal is $1 million. He can get a rate of return of 6%. Divide 72 by 6 and you get 12 years. The $250,000 becomes $500,000 after 12 years and $1 million by year 24.

Good news: Your client is adding money along the way.

Bad news: He’ll need a lot more than a million dollars.

Outcome

Your client knows the return he needs to reach his goal. You measure performance on the blended portfolio versus the Family Index, not the broad market.

If the client’s time horizon is long, the return target could be modest. Get a couple back-to-back great years and you’ll potentially exceed those numbers.

Recalculate the return they need going forward. Make adjustments from time to time. Getting ahead means you can take less risk going forward—an excellent strategy as they age. But don’t conclude he can skip contributions.

In turbulent times, pay close attention to asset allocation. Earning interest from the fixed-income portion and owning dividend-paying stocks produces some income when the markets aren’t cooperating. Scheduled reviews and recalculations are key. If you’ve gotten ahead of the game in good years you’ve developed a cushion for the turbulent years.

Worth the effort?

The client’s highest priority should be reaching his goal. The Family Index keeps him focused. He should be paying less attention to the indices (which may involve more risk than he’s comfortable with) and devote more attention to staying on track.

It’s difficult for advisors because sometimes markets have negative returns. That’s when having gotten ahead with dividends and interest makes a difference.

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