The Edmond Sun

May 16, 2014

Find your own investment benchmark

Nick Massey
The Edmond Sun

EDMOND — When talking about investing, sooner or later the conversation turns to performance. Of course, everyone wants to know how their investments have done. But the follow-up question should be “compared to what?” If your portfolio earned 5 percent and you’re a conservative investor taking little risk and trying to beat the risk free rate of return (basically 0.5 percent now), then you did pretty well. On the other hand, if you were investing aggressively to beat the S&P 500 that returned 30 percent and you made 5 percent, well that’s not so hot.

When it comes to investing, much of our deeply engrained “human nature” works against us  tripping us up when we can least afford a fall, and pitting ourselves against our own success.  Benchmarking, comparing to an investment benchmark or index, is one of those natural, yet self-sabotaging, tendencies.

We’re all inclined to do it, yet it doesn’t help us reach our most important, personal goals. There is a better way. So let’s talk about benchmarking. Even Warren Buffett isn’t immune. Although the “Oracle of Omaha” has proven himself a master investor during a multi-decade period, his Berkshire Hathaway’s relative “lackluster” performance in the past few years has prompted many to wonder if he has lost his Midas touch.

Yet, Buffett’s returns are only lackluster if you compare them to stock market indices, like the S&P 500 or the Dow Jones, today. Shares of Berkshire Hathaway have returned an average of more than 14 percent annually during the past four years. Those are returns that any reasonable investor should gladly accept. (Of course, this is just for illustration and to make a point. I am not suggesting you should or should not invest in Berkshire Hathaway.)

Still, critics of Buffett’s long-term, value-investing approach will show you a chart plotting Berkshire’s returns relative to the Nasdaq 100 Index since March 2009. Based on the comparison to the Nasdaq 100, they’ll conclude that Buffett is falling behind and not deserving of your hard-earned investment dollars. I think that’s a false conclusion and an example of how benchmarking can lead investors to poor, money-losing decisions. The pitfalls of benchmarking are many, but the two most important to know are these:

First is the apples to oranges comparison. Many times, the comparison of two stocks — or a stock to a market index — doesn’t make sense. Warren Buffett doesn’t invest much in growth-style technology stocks, so why would a comparison to the Nasdaq 100 Index make sense? It doesn’t. Yet the comparison is still made.

But there’s a bigger problem with benchmarking. It has no relation to your personal financial goals. Here’s a question for you. If “Stock A” averages 12 percent annual gains, but can drop 40 percent in bear markets; and if the Dow averages 8 percent annual gains, but only drops 25 percent in bear markets; which investment will allow you to retire comfortably?

Obviously, that’s a trick question that can only provide nonsense answers. And that is the trouble with benchmarking. Although it is human nature to compare things — to compare ourselves to our peers and our investments to market averages — the process doesn’t help us reach our own, personal financial goals.

Don’t just take my word alone for it. Consider a key conclusion reached by Dalbar’s 20th Annual Quantitative Analysis of Investor Behavior report. In their own words: “Investors should not judge their investment success by market index comparisons but instead, they should evaluate their progress towards achieving personal financial goals.”

Dalbar’s study goes on to delve deeply into statistical proof that shows investors have historically underperformed the stock market. It reminds us of the humbling fact that “the average investor cannot be above average.” And it shows how the long-term return of the Dow is nearly double the return achieved by the average investor.

For many investors, the process of benchmarking inevitably leads to performance chasing, whereby they invest in stocks, or funds, that have outperformed the market in recent history, while ignoring stocks and funds that have underperformed. And then, thanks to Murphy’s Law, those historical trends reverse, leaving investors with losses on the new underperformers, and missed opportunities on the new out performers. Don’t fall victim to this temptation! Instead, judge your investment portfolio’s performance relative to your own personal financial goals and risk tolerance. In the end, that’s what really matters.

Of course, simply ignoring the natural urge to benchmark your performance will only help you avoid one of the many psychological pitfalls you face as an investor. You also need a proactive, well-defined investment game plan. You need to set realistic goals, like how much money you’ll need to save and by what age, to retire comfortably. And you need an emotion-free process that’s capable of getting you from Point A to Point B. If you don’t know how to do that, I encourage you to find a financial adviser who can help you. Thanks for reading.



NICK MASSEY is a financial adviser and president of Householder Group Financial Advisors in Edmond. Massey can be reached at www.nickmassey.com. Investment advice offered through Householder Group Estate and Retirement Specialists, a registered investment adviser.