An All-Too-Common Investment Mistake
Investors can get wrapped up in comparing their portfolio's performance to the wrong measures of success, but giving too much weight to arbitrary benchmarks can steer them into making some risky moves.
Much of what makes investing so interesting (or unsettling, depending on how you look at it), is picking products for your portfolio and then watching them go up or down.
Some people are better at choosing than others, or they hire someone who is. Either way, many investors can’t help but compare their portfolio’s proficiency against some sort of benchmark — typically the S&P 500 or the Dow Jones Industrial Average. Sometimes, though, it’s a neighbor, co-worker or brother-in-law boasting about great returns.
Maybe that last sentence probably made you smile, but in a way, all the benchmarks mentioned above have something in common: They don’t necessarily reflect your individual goals or risk tolerance. You’re comparing apples to oranges. And if you get sucked into that game, you’re in danger of making decisions — and mistakes — based on emotions.
How NOT to Think About Your Portfolio’s Performance
Here’s a hypothetical example. “Sue” went through the whole process of figuring out what she needed her portfolio to do for her to reach her retirement goals. And she was fine with where everything was going. Then one year she came into her financial adviser’s office — we will say the market was up about 20% — and she was unhappy because she’d only made 7% on one of her investments. That was more than the goal that had been set, and still she was not pleased.
Then a crash came. And her investment, an annuity, didn’t make any money — but she didn’t lose anything, either. Her adviser was expecting that she may be angry, but when she came into the office that same year, she was smiling.
Why the frown when she made 7% and the grin when she made nothing?
She told a story about her neighbor. When the market was up, this guy made 18% on an investment — and of course told everyone. It’s no wonder she had a serious attack of FOMO — fear of missing out.
Then the market dropped, and her neighbor lost 25%. Suddenly, she felt smart and, more importantly, safe.
It’s all about perspective.
A Better Way to Judge Your Returns
Now, I do think it’s fair, if you’re investing in a market-based portfolio, to compare a product or position to its peers. If you have a large-cap or mid-cap stock or a bond fund, you want to make sure it’s pulling its weight. But for an overall portfolio, I think it’s more important just to make sure you’re staying on track. That’s better than worrying about whether you’re keeping up with some random touchstone.
How can you create your own appropriate benchmark? Try working backward.
First, assess the situation. You may need the help of a professional to do this, or you may be able to do it on your own. The question you need to answer is, “Where am I now and where do I need to get to?”
Coming Up with Your Own Benchmark
Let’s say you’re 60 and you want to retire at age 66: What will your income streams be (Social Security, pension, etc.) and will you have a shortfall? It’s likely you’ll have to withdraw from your portfolio to fill an income gap. So, you’ll want to be sure you have enough in there to do the job.
Besides the additional money you can stash away between now and then, what rate of return will you need to average each year for the next six years to help you hit your goal? If it’s 4%, that’s your benchmark. And if you only need 4%, why would you invest in an index fund that could make more — but also lose much more?
Why not invest more conservatively, so if there’s a crisis in the market, you won’t blow up your plan, take a giant step back and possibly have to work another five years or more?
You’ve probably heard the expression “don’t chase returns.” It’s good advice.
Ignore the noise that’s out there — especially if it’s coming from a neighbor or your brother-in-law. Stay focused on your own goals and determine your own measures of success.
Kim Franke-Folstad contributed to this article.
Securities offered through Madison Avenue Securities, LLC (MAS), member of FINRA/SIPC. Investment advisory services offered through IMG Wealth Management Inc., a Registered Investment Adviser. MAS and Investment Management Group are not affiliated entities. MAS and IMG Wealth Management Inc. are not affiliated entities. Investing involves risk, including the potential loss of principal. A hypothetical example has been provided for illustrative purposes only; it does not represent a real-life scenario and should not be construed as advice designed to meet the particular needs of an individual’s situation.
About the Author
Investment Adviser Representative, Investment Management Group
Philip Detlefs is an Investment Adviser Representative with Investment Management Group. He has passed the Series 7, 63 and 66 securities exams and is a licensed insurance professional. He has a bachelor's degree in finance and marketing at Florida State University. He is married and has three children, Olivia, Harry and Hutch.