It is only natural to try to compare to others when considering “how am I doing?”. In the investment world, most Americans compare their portfolio to the S&P 500, an index of 500 large US companies that are publicly traded. If you are underperforming, is it time to make a change?
Most investors in reasonably well balanced portfolios feel like they are not doing well when they compare the past couple years to “the benchmark”. After all, the S&P returned over 30 per cent last year and over 15 per cent a year for the past three years. Many other investments failed to produce such spectacular returns and therefore well diversified clients underperformed this benchmark badly in recent years. Typical investor sentiment and behavior is to become a bit discouraged and move more money to the area that has been doing well-in this case, US large cap stocks.
The trouble is the S&P 500 Index is not the proper measure of your investment health! Your job is to accumulate enough money to fund and achieve your financial goals. Let’s ask you a serious question- would you prefer to have a portfolio that gives you a 95% chance of achieving your financial goals (and only 5% chance of ending up with twice as much money as you need) or a portfolio that give you a 70% chance of achieving your financial goals and a 30% chance of ending up with twice as much money as you need?
If your answer is the second portfolio with a 70% chance of achieving your goals, perhaps an inherently risky benchmark like the S&P 500 really should be your benchmark. If you prefer the 95% success rate offered by the first portfolio (I know I would), then a diversified portfolio constructed in order to maximize your success should be what you compare your results to. It won’t be spectacular, but it will help you sleep at night when there are storm clouds in the markets and finish your race as a winner.
Dr. Craig Israelsen recently published 15 year results for twelve different investment classes. Over that longer time period, returns in the S&P 500 were less than half of returns for Midcap US Stocks, Small Cap US Stocks, Emerging Market Stocks, Real Estate, Natural Resources, or Commodities. US Bonds and TIPs (Treasury Inflation-Protected Securities) also outperformed US Large Cap Stocks for the past 15 years. All but Small Cap US Stocks achieved this better performance with less volatility.
Better still was a portfolio that combined each of the twelve asset classes. You nearly doubled the return over US large cap over the last 15 years, and you reduce the volatility by close to 80%.
So, jumping aboard the latest hot performer as your benchmark is neither a rational way to pursue your goals nor is it likely to prove to be a winning idea over the long haul. Run your own race.
By Ted Schwartz, CFP©