I had someone visit me in my office recently who complimented me on my recent book Unconventional Investing. He said he took particular interest in Chapter 9 which outlines my tactical ETF portfolios. He mentioned how impressed he was with one of the portfolios which would have returned over 40% in 2008 (during the severe bear market). However, to my surprise at that moment, he was then quick to express his disappointment that in 2009 its performance would have significantly trailed the S&P 500 (yet, still providing a positive return). *Performance numbers provided by etfreplay.com.
*Note: the portfolio he was talking about is one of three I outline in the chapter and it is titled “The Starting Five.” From 2005 through 2013 it produced a 262.5% total return with no negative years. At the same time the S&P 500 outperformed “The Starting Five” in five of those nine years, only had one negative year (2008), yet significantly underperformed my highlighted portfolio over the long term by only netted an 83.4% total return. Of course, 100 people out of 100 would rather have 262.5% return as opposed to 83.4%, yet many (like this person I referenced above) may disregard the fantastic results because of a non-rational obsession with beating “the market” every single year. By the way, if you can find such a strategy, (friendly challenge) PLEASE email me . . . I am not going to hold my breath waiting.
I then reminded him that investing is like a baseball game whereby it is impossible to “win” every inning, no team can do that. However, as long as you get consistent returns and do not “blow up” in any one inning (or year, in the case of the market) then you will most likely come out ahead and win the game.
What hit me was that I was talking to a stone wall. My words were not sinking in or resonating with him as if a magical spell was clouding his thinking. It was clear to me that his only concern was beating the market every single year for the rest of his life, whether that has any relevance to his real life or not.
By the way, if you too share this obsession, let me ask you a question: would you be happy with a -36% return in 2008? If not, why not? Because that return beat the market. If -36% is not satisfactory to you, then for your own sanity, please stop obsessing about outperforming the S&P 500.
I was left partly frustrated knowing that my portfolio is hands down better, yet it was being somewhat dismissed by him. At the same time I was fascinated with his believe system and need to consistently compare portfolios to the S&P 500. This isn’t new, I have seen this “obsession spell” before and literally drive some people mad. However, it was this recent meeting (that left me shaking my head) that finally prompted me to address this issue in a blog post.
Again, why would someone dismiss a (in my view) clearly superior long term investment portfolio simply because it failed to outperform the market every year? Is this a smart line of thinking and analysis?
I believe part of the blame for our collective obsession with the U.S. stock market is because that is all we are consistently exposed to. I blame the media. On the news at night (every night) the anchors report on the movement within the S&P 500, Dow Jones, and Nasdaq stock indexes, as if that is all there is and as if they were all so unique and different. However, that is not all there is (as I address below) and they are not all that different, as they are all large cap U.S. centric stock indexes. Being all of the same type (or asset class) means that if one these index moves, typically they all move – in unison. *Note: over the past decade the S&P is 97% correlated with the Dow Jones and 90% with the Nasdaq indexes (Source: iShares Correlation Calculator). This type of reporting causes us (as viewers) to then focus (and obsess) on this one asset class: large cap U.S. stocks, which may not be a productive use of our attention and energy.
For the news to only report on these three indexes I believe is doing the audience a disservice and provides little value. This is analogous to wanting a weather report for the continental U.S., but only getting updated reports from three cities close to each other, like Boston, Worcester, and Springfield (for MA residents). They are most likely all going to report similar conditions. What is the point?
Is your obsession with “the market” even relevant?
Would you agree that a 100% U.S. large cap stock portfolio like the S&P 500 is aggressive? On a scale of 1 (being conservative/cash) to 10 being aggressive, you would have to put a portfolio invested 100% in the S&P 500 in the 8 – 10 range. Yet, the vast majority of people (that I talk to) when questioned about their risk tolerance, indicate that they are NOT aggressive (in the 8 to 10) range and/or would not want to relive the negative declines of the market that we have witnessed in recent history. Therefore, if you are not aggressive, why would you consider comparing yourself to this benchmark? If you do you are only going to be disappointed, because just like in aforementioned “The Starting Five” example, there isn’t a portfolio that will always outperform every single year (again –friendly challenge - if you find one let me know).
Don’t compare apples to oranges + bananas + pineapples + grapes + plums
Do you believe in diversification? Most people know they should. That characteristically means a multi-asset (multi-market) portfolio. What are asset classes? Large and small U.S. and internationally based stocks, emerging markets, real estate, commodities, domestic and foreign bonds, currencies, just to name a few. Diversification (again) inherently means you have a mix of many asset classes, many markets, not just one. In theory, a diversified portfolio will produce less volatile returns than just owning one aggressive asset class. For most people this is appealing, but it also means that there will be years (like recent ones, as opposed to the early 2000s) when one of the best performing asset classes is Large Cap U.S. Stocks. Therefore, if you are comparing your portfolio to “the market” or just large cap U.S. stocks, you most likely have snapshots in time where you will be disappointed. I wouldn’t recommend doing this, there is no point. You are just subjecting yourself to a cruel form of mental torture.
The problem: Mental torture leads to emotional triggers, which leads to emotional portfolio decisions, which leads to chasing returns and long-term underperformance (reported on many times by research firm Dalbar).
A Healthier Outlook: Know that in a diversified portfolio you have some exposure to large cap U.S. stocks. If “the market” is up, a portion of your portfolio is as well. If “the market” is down, (only) a portion of your portfolio will be as well. In addition, instead of using the S&P 500 as your portfolio benchmark, use well-diversified asset allocation fund (conservative through aggressive).
In Sum: Diversify, and tailor your portfolio to your risk tolerance. Stop comparing yourself to just one aggressive asset class, it is not a productive activity. You will only get yourself worked up and very little good comes from that. One of the conclusions I arrived at after writing Unconventional Investing is that people are emotional beings and we are best served by implementing (to the best of our ability) systematic (unemotional) portfolio management systems.
Again, try to avoid the “obsession with the market spell,” because it will cloud your vision and challenge your sanity.
For more information on this topic I recommend you read this article by Professor Israelsen: http://www.7twelveportfolio.com/Downloads/Smarter-Way-to-Benchmark-FP-June-2014.pdf
Tim Higgins, Author of Paying for College Without Sacrificing Your Retirement and Unconventional Investing