Build a Rainbow, Not the Pot of Gold

Investing
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By Richard Russo

Learn more about Richard on NerdWallet’s Ask an Advisor

I’ve always found the Skittles ad campaign “Taste the Rainbow” bothersome. The thought of brightly colored candy pelting me from the sky never appealed to me.

It reminds me of how when it comes to finances, we care more about the pot of gold than the rainbow. The Skittles campaign represents the proper mindset for those who seek to be successful with money management.

It’s a stretch, right? Not really.

Think of it this way: Skittles people could care less about what’s at the end of the rainbow — the rainbow itself is the heart of everything. It even makes them giddy and provides a sugar high to boot.

Unfortunately, some of us want immediate gratification – the pot of gold —  without the strong resolve and discipline necessary to build a colorful path to reward. We want the prosperous results of long-term discipline, such as wealth, security and peace of mind, but we’re not willing to evaluate risk.

Seeking reward without assessing risk

Many of us don’t understand how to assess risk even though we hate losses twice as much as we love gains. Achieving respectable return with little or no risk is impossible. Like two sides of a coin, you cannot separate heads from tails.

History is littered with emotional reactions to money manias. Whether it was betting on Dutch tulips in the 17th century or social media stocks today, we have become overwhelmed with seeking return at the expense of mitigating risk. If your concern is return alone, then you’re a speculator, not an investor.

People impressed by an ability to beat the stock market do not care about your needs. Is it interesting? Yes. Would it make for terrific conversation? Sure. But understand, “beating an index” is an ego stroke.

Seeking to beat a market benchmark like the S&P 500 is not a financial accomplishment. It’s a way to fill the pot with fool’s gold before the rainbow. Unless you sold gains, paid off a debt, or sent a kid to school, the act is the equivalent of beating your chest like a gorilla, except a gorilla is not going to pound and scream while standing out on a limb 50 feet in the air. The outperformance you’re basking in today will be gone tomorrow because you’re out on a dangerous branch and don’t realize it.

In a 2000 research paper, Bard College economics Professor Edward Wolff found that two-thirds of American households failed to increase their retirement wealth from 1983 to1998. Through one of the biggest bull markets in history median household retirement wealth decreased by 13%!

Building your rainbow

Financial life benchmarking helps you understand the returns necessary to get where you want to be. It’s about you, not a market index: It’s your life, your attitude toward money, what’s important about having it to meet lifestyle goals, all combined in a functional action plan. It’s your rainbow and the colors are unlike any others.

What is a benchmark? A benchmark is a standard by which others may be measured or judged.

In addition to devising a way to measure or judge your financial success, consider who is measuring and judging you based on your financial decisions. How will you be judged if you lose 50% percent of your family’s investments? What if your children can’t receive the education you planned because you took on too much risk? These are important benchmarks to consider.

The best rainbow to personal success is achieved through financial life benchmarking. A pot of riches just doesn’t happen — you need to work at it. Financial life benchmarks are specific goals you create, accomplish and check off. They move you forward and bolster your household balance sheet along the way.

There’s a law of diminishing returns (I call it “financial wheel-spinning”) where you’ll take on more risk and not receive a commensurate amount of return. A bell doesn’t ring when you approach or breach the danger zone, and financial life benchmarking is a framework designed to help you avoid this pitfall.

Here’s how you can start building your rainbow:

Create a written process to strengthen the rainbow and arrive successfully at the pot: Find a qualified partner to help you understand how much money or real return you require to reach a goal. Also have a written action plan to correct shortfalls if results fall below what’s required.

Monitor progress quarterly, or at a minimum annually, to remain involved and to readjust the focus on your life return, not the performance of some impersonal market benchmark.

Instill a peace of mind as you trade return on investment for return on life: Setting up millstones that lead to milestones allows you to focus on behavior, your actions, your life and needs, not  some arbitrary index.

Ponder this: Would you feel more satisfaction if you realized that you:

1. beat the market or some index, or

2. are able to send your son or daughter to college?

Beating the market is not a long-term accomplishment; it happens because you are lucky! Never mistake luck for skill, especially in bull markets.

Are you ready to trade the sugary candy for something substantial?

Then consider financial life benchmarking.