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8/9/13 – More About Quantification and Investing

Written by Brad McMillan, CFA®, CFP® | Aug 9, 2013 1:57:38 PM

It’s a slow news day on the economic front, and Jackson and I are on a plane to visit his grandparents, so I thought I’d extend the conversation about personal quantification and investing.

The idea “if you can’t measure it, you can’t manage it” is just as applicable in personal goals as it is in business. Maybe more so, because in your personal life you don’t have a net profit line to tell you whether you’re doing well. I’ve found that measurement can provide the impetus to keep going and to modify behaviors to be more effective.

A good example is the heart rate monitor. As a way of measuring how hard your body is really working, the heart rate has no equal. As a way of tracking actual effort, and how that translates into the results you want, I’ve found a heart rate monitor to be essential.

It’s pretty self-explanatory—a strap around your chest that tracks how fast your heart is beating. You can then see what percentage of your maximum heart rate you’re working at and use that to guide your workout. Different people have different maximum rates, but the monitor tracks what you do, not some abstract results.

With exercise, more isn’t necessarily better, something I’ve had a tough time learning. For me, sustained effort at around 70 percent of max is much more effective for both weight loss and cardio conditioning than trying to max it out—as well as being much more sustainable over time. A medium-fast walk is actually the best workout for me, given my current goals. The monitor forces me to live within my limits, which has become more important as I’ve aged, and demonstrates actual progress that I can refer to when I get discouraged.

It also serves as a more accurate guide to calories burnt, either during a workout or just throughout the day. Because the monitor incorporates how hard you’re actually working, the results are more accurate than simple time and activity estimates. This information is invaluable in tallying my net calories per day. If I work out more, I can eat more. That’s a great incentive.

The equivalent of a heart rate monitor in the investing world is the benchmark. A portfolio’s performance can be measured in at least two ways—as the absolute return and compared with something else. Both methods are useful. The absolute return can be compared with your goal, for example, but the benchmark allows a more realistic appraisal of how things are going over any given time period.

For a benchmark to be useful, of course, it has to be representative of what you’re invested in. If I benchmark my heart rate against Lance Armstrong’s, for example, the results won’t be either encouraging or useful. But if I use other late-40s office workers, that will give me a better idea of where I stand. Similarly, if I have a portfolio with a mix of stocks and bonds and compare it to a benchmark of all stocks, I’m not really learning anything.

This is particularly relevant today, with many clients and advisors questioning their portfolios as the stock market climbs higher. Why aren’t I matching the stock market?, they want to know.

A good question. Why aren’t I matching Lance Armstrong? Well, first, because I’m not an elite athlete, and second, because I’m not willing to make the same effort and take the same risks. Risk is really the appropriate metric in investing.

If you’re underperforming the stock market on the upside and outperforming it on the downside, that can still look pretty bad on the upside—which is where we are now. If, on the other hand, you look at how your portfolio is doing based on a realistic comparison—say, the stock market and the bond market combined in the appropriate ratio—that will probably be more encouraging.

The key to success in any difficult area—weight loss or investing—is sustainable effort, realistic targets, and a plan that can be both monitored and modified if necessary. Realistic performance appraisal makes all that possible, so I recommend using a heart rate monitor for exercise and reviewing the benchmarks you’re using for your investments.