In many spheres of life, we play the comparison game — usually to our detriment. One day we’re perfectly content driving our 10-year-old Toyota. The next day, when our neighbor pulls up in a brand new car with all the latest bells and whistles, suddenly our car doesn’t seem so great anymore.
Social scientists have long noted that this is part of our human nature. We base our contentment on comparisons to our own previous circumstances, or more commonly, to other people. It’s why scrolling through social media feeds can be such a contentment killer. Because it’s virtually impossible to opt out of the comparison game, it’s important to be intentional about choosing our points of comparison.
That’s true in many spheres of life, including investing. Daily reporting about “the market,” especially at a time of high volatility, such as what we’ve experienced this year, can foster much unnecessary anxiety and fear. We would be wise to consider what we’re benchmarking our portfolio against.
Here we could take a lesson from former Speaker of the U.S. House of Representatives Tip O’Neill, who is widely associated with the phrase “All politics is local.”
What exactly is "the market"?
For many investors, their default benchmark is “the market” — whether that means the S&P 500, the Wilshire 5000, or the Dow Jones Industrial Average. There are three potential problems here.
First, those benchmarks are quite different from each other. The S&P 500 measures the composite performance of about 500 leading large-cap companies. The Wilshire 5000 measures the combined performance of most U.S. based publicly traded companies — large, medium, and small. The Dow tracks the collective performance of just 30 large U.S. companies. On any given day, the performance of each benchmark can vary quite a bit from the other two, so which one really represents “the market”?
Second, and more importantly, “the market” is highly unlikely to be representative of your holdings. If your portfolio is 60% stocks and 40% bonds, is it fair to compare its performance to an all-stock benchmark?
Third, a benchmark makes no provision for contributions or withdrawals. If you are dollar-cost-averaging into an S&P 500 index fund, for example, your results will likely differ from the benchmark’s results. Because you weren’t fully invested for the entire period, you’ll tend to do better than the benchmark in a down year but worse in an up year.
The best benchmark for you
So which benchmark should you use? At SMI, we regularly report our strategies’ performance along with that of the Wilshire 5000. We realize it’s natural for most investors to want some sense of how they’re doing relative to the overall stock market and we believe the Wilshire 5000 presents a more accurate picture than the S&P 500. Still, it’s a far from perfect point of comparison since none of our strategies call for investing in a single index fund designed to mimic the U.S. market.
When it comes to evaluating the performance of your portfolio, the most relevant benchmark is the average annual return figure you used in developing your investment plan. That’s the best way to keep investing “local.”
How do you arrive at that figure? Because I tend to err on the conservative side, I recommend mixing one part historical performance of the major asset classes represented in your portfolio and three parts highly-managed expectations. In our household, we use 7% as an assumed long-term average annual return. That’s arguably overly conservative, but we’d far rather be surprised by a better result than the other way around.
This 7% benchmark has left us especially happy with the performance of SMI’s Dynamic Asset Allocation strategy, which my wife and I use to manage a large portion of our portfolio. If the Wilshire 5000 had been our benchmark, we might have been disappointed with DAA’s 2013 gain of 16.2% since the Wilshire zoomed upward by 33.1%. We might have been tempted to alter our portfolio to take on more risk in pursuit of better performance, and in doing so, we might have assumed we could afford to invest less each month. Instead, we were more than pleased to share in that much of an up market’s gain using such a low-volatility strategy.
Same for 2020. We were pleased with DAA’s 12.4% gain even though the Wilshire gained 20.8%. Not only did DAA exceed our personal benchmark, it delivered that result with far less volatility than the market during the scary early days of the pandemic. It did wonders for our peace of mind to see DAA falling far less than the market when it swooned 34% in just 16 trading days.
We may have little control over our tendency to play the comparison game. However, especially when it comes to our investment portfolios, we have a lot of control over our choice of benchmarks. Choosing well will make us happier, more successful investors.
What benchmark(s) do you use with your investments?