Learning From My Misguided Attempt to Beat the Market

I knew the Practical Investing portfolio was lagging its benchmark badly, so I did what I thought any reasonable person would do: I stopped looking at it. After all, contemplating my underperformance gave me a headache, and I could think of a million better things to do than stare at my investments all day.

But a reader, who was thinking about shifting from investing in index funds to picking her own stocks, asked about the portfolio’s performance. So I took a peek at the numbers, then sighed. Despite a great return during my sabbatical, the portfolio’s results since its launch in October 2011 have been underwhelming. Through August 31, the portfolio, which is now worth $283,384, earned 49% (or 8.3% annualized). However, my bogey, Vanguard Total Stock Market Index ETF (symbol VTI), returned 84% (13.0% annualized). Normally, a return of 8% a year would be just fine. But compared with the benchmark, my results seem paltry.

Naturally, this caused me to think about Kiplinger reader surveys that show most of you like my column. Perhaps its popularity is like the popularity of “Dear Abby.” People read the letters from desperate writers and think: “Well, I may have just lost my job, but at least I’m not married to a drug-addicted thief. Things could be worse.”

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Better elsewhere. Interestingly, my long-term results outside the Practical Investing portfolio look much better. My overall portfolio, of which Practical Investing is just a small part, returned 10.0% annualized over the past 10 years, compared with 7.8% a year for the Total Market ETF.

So what on earth is wrong with the Practical Investing portfolio? Among other things, I realize that I’ve deviated from my normal style, which is to buy things and then completely ignore them, in this open-to-all-eyes portfolio. Do they win? Do they lose? I don’t really know. I hang on unless something happens that turns me off to a company.

Out of curiosity, I checked to see how I would have fared had I kept every stock I bought at the outset of my Kiplinger portfolio. Despite three picks that turned out to be dogs—Schnitzer Steel Industries (SCHN), Chinese online media company Sohu (SOHU) and Stone Energy (SGY)—I calculate that the portfolio would have been worth almost $40,000 more today and that I could have claimed a better (though still-lagging) return of 69%, or 11.1% annualized.

The past five years have been tough for fund managers everywhere. Barron’s recently explained the phenomenon with a thoughtful piece about “the unusual set of obstacles” that have plagued actively run funds since the financial crisis of 2008. Among other things, central banks everywhere have driven down interest rates to microscopic levels. That in turn has increased demand for stocks and pushed up prices for nearly all shares because investors get little to no income from bonds and bank accounts. Oddly enough, it also created an environment in which speculative stocks have outpaced the sort of well-established, high-quality companies that I (and many fund managers) prefer. Moreover, because returns on cash are negligible, any cash cushion you hold to guard against a steep decline also drags down returns. In short, it’s an environment that fries anyone who is even slightly risk-averse.

Beyond that, my misguided attempts to beat the market by selling high-quality stocks, such as Lockheed Martin (LMT), to buy lower-quality stocks, such as Acacia Research (ACTG), which subsequently blew up, hurt returns. As a result, I am returning to my old, boring approach to stock picking. In the meantime, if you want a real confidence booster, compare my portfolio’s returns with your own. You’ll doubtless walk away saying, “Sure, I haven’t been able to beat the market. But things could be worse.”