You receive portfolio performance reports every three months to six months—a form of transparency that financial planning professionals introduced at a time when the typical brokerage statement was impossible to decipher. But it might surprise you to know that most professionals think there is actually little value to any quarterly or semi-annual performance information, other than to reassure you that you actually do own a diversified portfolio of investments. It’s very difficult to know if you’re staying abreast of the market, and for most of us, that’s not really relevant anyway.
The only way to know if your investments are “beating the market” is to compare their performance to “the market,” which is not easy. You can compare your return to the Dow Jones Industrial Average, but that index represents only 30 stocks, all of them large companies. Most peoples’ investment portfolios include a much larger variety of assets: U.S. stocks and bonds, foreign stocks and bonds, both including stocks of large companies (large cap), companies that are medium-sized (mid cap) and smaller firms (small cap). There may be stocks from companies in emerging market countries like China and Mexico. There may be real estate investments in the form of REITs and investment exposure to shifting commodities prices, like minerals, and oil.
In order to know for sure that your particular batch of investments outperformed or underperformed “the market,” you would need to assemble a “benchmark” portfolio made up of index funds in each of these asset categories, in the exact mix that is in your own portfolio. Even if you could do that precisely, daily, weekly and monthly market movements would distort the original portfolio mix by causing some of your investments to gain value (and become larger pieces of the overall mix) and others to lose value (and become smaller pieces), and those movements could be different from the movements inside the benchmark. After a month, your portfolio would be less comparable to the benchmark you so painstakingly created.
Many professionals believe that there are several keys to evaluating portfolio performance in a meaningful way—and the result is very different from comparing your returns with the Dow’s.
Take a long view.
What your investments did last month or last quarter is purely the result of random movements in the market, what professionals call “white noise.” But you might be surprised to know that even one-year returns fall into the “white noise” category. It’s better to look at your performance over five years or more; better still to evaluate through a full market cycle, from, say, the start of a bull market to the start of a new bull market. However, you should remember that there are no clear markers on the roadside that say: “This line marks the start of a new bull market.”
Compare your performance to your goals.
Your financial plan indicated that your investments needed to generate (let’s suppose) 4% returns above inflation in order for you to have a great chance of affording a long, comfortable retirement. If that’s your goal, then chances are, your portfolio is not designed to beat the market; it represents
Recognize that some of your investments will go down even in strong bullmarkets.
The concept of diversification means that some of your holdings will inevitably move in opposite directions, return-wise, from others. Ideally, the overall trend will be upward—the investments are participating in the growth of the global economy, but not at the same rate and with a variety of setbacks along the way. If you see some negative returns, understand that those are the investments you’re counting on to give you positive returns if/when other parts of your investment mix are suddenly, probably unexpectedly, turning downward.
That doesn’t mean you shouldn’t look at your portfolio statement when it comes out. Make sure the investments listed are what you expected them to be, and let your eye drift toward the longer time periods. Notice which investments rise the most and which were down and you’ll have an indication of the overall economic climate. And if your overall portfolio beat the Dow this quarter, or over longer periods of time, well, that probably only represents white noise.
To summarize, the lessons outlined above can guide you to your goals, and we can re-state them in the following key factors:
- Take the long-term view.
- Track your performance to your goals.
- Recognize that markets are unpredictable over the short term and that sound diversification that matches your goals, risk tolerance, and time frame will guide you on your road map.
We thank you for your continued trust and loyalty, and the opportunity to serve you and your families.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
Blog No. 118 – What does it mean when your portfolio is up 6%, 8% or 10%
Sources: Dimensional Fund Advisors, LPL Financial Research, Mercer Putney Financial Advisors, Inside Information and Nick Murray Interactive.