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Chasing Benchmarks

By: Darren Coleman

Published: October 27, 2017

In my new book ‘Recalculating: Find Financial Success and Never Feel Lost Again’, I tackle a number of common challenges in financial planning that cause even very sophisticated people to lose their way. One of these is how investors can go about evaluating the success or failure of their investments.
A logical way to do that is to focus on the rate of return needed to achieve or meet your goals. But most investors don’t do that. Instead, they struggle to try and match the performance of some other benchmark, such as the S&P500 or the Dow Jones. These indexes show the composite performance of a basket of stocks and there is a specific rationale at play for how each benchmark is created.
It is interesting to compare the performance of something like a mutual fund to its relevant benchmark. However, neither the investment nor its benchmark should be used as the sole criteria for assessing the complete portfolio. They are best used as a weather gauge; if the benchmarks are up, then you should be up, and if they are down you can expect to be down. This means if they are up by eight per cent and you are up by 7.5 percent, you have not underperformed. Not at all. You are still doing well. My point is that unless your portfolio has taken the same risks as the benchmark, then it is not a simple apples-to-apples comparison. And yet, many investors assess the quality of their portfolios on the sole characteristic of whether or not they ‘beat the market.’

Beating The Market

It is very important to understand that beating the marketis not a financial goal. What is a financial goal? Well, here are three good ones:

  • Retiring comfortably.
  • Sending your kids to college.
  • Paying off your mortgage.

Successful investors have clear financial goals and always mark their progress towards these goals. In other words, they are constantly focused on the destination. But poor investors spend too much time chasing benchmarks and paying too much attention to what the other cars are doing on the road.

Indeed, my book likens managing finances and investments to driving a car. Just about everyone drives, but they often need direction, so what I did here is take the GPS approach – hence, ‘recalculating.’ The book targets those who might be unsure where they are in terms of their money and assets and, while that represents a lot of people, I especially target young adults and Boomers who are at or near retirement age.

Using this driving analogy, I have developed three presentations:

  • Taking the Wheel – to guide female entrepreneurs in having full control over the vehicle for their wealth creation
  • Junk in the Trunk – to instruct newly married couples, both young and old, to learn how to put two financial lives together
  • Learning to Drive – to support those who are suddenly single and now need to plan on their own

Let’s hit the road for a moment and look at some of the things that might slow you down.

The Dreaded Brother-In-Law Index

Trying to beat someone else’s investment performance is probably the worst example of benchmark chasing. You may have a friend, neighbour, co-worker – or the brother-in-law – who is always bragging about the money they made in the stock market. Of course, you never see or hear about the money they lost or about the risks that they took. In Las Vegas, everybody is a winner, right?

The fact is this person may or may not be a more successful investor than you. All you know is that they love to toot their own horn. Be aware that trying to beat them is a fool’s errand. What matters is how you progress towards your own goal, with your own set of facts, opportunities and challenges. If your doctor tells you to get your cholesterol down to a certain level, comparing your cholesterol to that of Lance Armstrong is a pointless exercise. It is the same with investment portfolios. The only portfolio that matters is yours.

Racing

So, trying to race ahead and beat a benchmark is not a financial goal. Along with being the wrong focus, it is also a fruitless pursuit.
Dalbar, a financial services research firm, publishes a study that examines how investors actually do relative to key benchmarks out there. This report, called the ‘Quantitative Analysis of Investor Behaviour,’ has been produced every year since 1994 and is widely read and respected. Dalbar compares not just what markets did, but what investors actually received. In the 2014 report, Dalbar reported that the S&P500 delivered an annual 9.85 per cent over the past 20 years and that return was derived from doing absolutely nothing. Nothing! Simply holding the index over 20 years and allowing it to rebalance itself would have provided that rate of return.

Now, one would expect that an active investor doing anything at all would have improved on that return. If doing nothing got you better than nine per cent, then doing something ‒ such as watching the business news, reading the business papers, listening to economists and strategists, talking with your stockbroker, whatever ‒ should have given you a better return. If it didn’t, then you should stop doing it.
What Dalbar found is that investors received less than what the market delivered. The average investor did not earn 9.85 per cent. The average investor earned 5.19 per cent. Let’s have another look at this.

Active Investors Underperform Their Own Investments

Not only do active investors underperform their own investments, they underperform them by quite a margin. In fact, they received about half of what their portfolio could have returned had they just left it alone. Keep in mind that this is not a singular event, limited to only this one study. Dalbar sees this same experience in every annual study it has done. The numbers may change a bit each year, but the degree of investor underperformance stays the same.

Fidelity Investments did a study of its client portfolios from 2003 to 2013 and found that its best investors were those who never touched their accounts. Indeed, Fidelity discovered that its most successful investors were those holding dormant accounts because these accounts were already dead. Next best group? Those who forgot they had an account at Fidelity. The client group that had the worst investment performance? Active day traders. There’s an old joke amongst stockbrokers: a portfolio is like a bar of soap ‒ the more you touch it, the smaller it gets.

Why is this the case? The answer is simple. Investors are human! We make mistakes all the time, and investors make the same mistakes with great reliability and this is usually because they are driven by the emotional challenges of investing.
One of the greatest emotional difficulties for investors is to ignore what the markets are doing and just let their investments be. Louis Rukeyser, the late host of Wall Street Week, had wonderful advice for investors in times of market stress. He said: “Don’t just do something ‒ stand there!”

If your portfolio is not doing well, maybe it’s not your investments that are the problem.
Perhaps it is you. So slow down and let the portfolio work.

Darren Coleman is an investment manager who is fully licensed in Canada and the United States. His book ‘RECALCULATING - Find Financial Success and Never Feel Lost Again’ is available on Amazon and at https://www.recalculatingwealth.com

 

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