Compared to What?

Dollars & Sense June 2014

Q. I’ve spent a lot of time picking great stocks, a few mutual funds, and some gold. I’m making money, but I don’t think my portfolio is keeping up with the S&P500. What am I doing wrong?

A. The only thing I can tell you’re clearly doing wrong is comparing apples to oranges. You’re not alone as I see this all the time. At least you’re tracking performance and trying to assess your success. But when you assess a portfolio and its performance, you have to ask, “compared to what?”

Before we get to appropriate benchmarks, let’s review the investment process. First, all investors need to assess their situation; age, liquidity, taxes, tolerance for volatility, experience, and other unique factors. Based on your answers, you (or your advisor) can come up with an overall, long‐term, strategic plan for your portfolio. Only then, should you proceed toward investment selection to fill in your portfolio plan. Most people want to skip the strategic plan aspect and get right to the “fun stuff”: picking stocks or funds. Assuming you did these steps, it’s the strategic plan, and the resulting “asset allocation” that drives what you should use for performance comparison. Let’s use a simple example to clarify. Assume your plan calls for 25% Bonds, 65% Global Stocks, and 10% Alternatives (like commodities, and reits). Your benchmark, then, should match your plan. In this case, your benchmark should be a weighted blend of, say, 25% Barclays Aggregate Bond Index, 65% FTSE Global Stock Index, and 10% DJ‐UBS Commodity Index. This may sound difficult to do but nearly every money manager has the means to do this for you. In this sample portfolio, the U.S. stock market would only be about 35% of the portfolio so comparing the whole portfolio to the S&P500 (a U.S.‐only stock index of large companies) would be totally inappropriate; apples to oranges.

What about absolute benchmarks? Often, investors will say, “I just want to make money.” If that’s really true, you’re telling your advisor (or yourself) to swing for the fences and go for the biggest return. Ah, but then you’re reminded of risk and volatility and you might add in an additional mandate, “But oh, I don’t want to lose money, either.” What you’re really saying is you want to make the most amount of money, but within some level of risk. I do think it’s reasonable to have some kind of hoped for absolute return expectations. Although markets have cycles of good times and bad times, most everyone has some kind of absolute goal for returns over a complete market cycle like, “I’d like to average 10%/year, without ever losing more than 10% in any given year.” You really should consider long‐term returns of various asset classes to determine what’s reasonable, but the point is to set an up/down absolute number.

My recommended approach to monitoring portfolio performance is a hybrid approach. Establish your long‐ term strategic plan and asset allocation. Use this as your relative blended benchmark. Then, pre‐determine an absolute return expectation for upside & downside. Compare all three. And most importantly, measure all three regularly and over a complete market cycle – a bull and a bear market, combined. That might be 5 years or more. The key is to keep track of it, in writing, and to review it regularly (quarterly, at least). If it were my money, I’d want to know how my money is doing in dollars, in percentages, and relative to the appropriate blended benchmark. And I’d want to see, in writing, how I did in the most recent quarter, year‐to‐date, and for each of the past 5 years. This is the standard for institutional and endowment money – why shouldn’t it be the same for you?

Any credible advisor or money manager should be able to provide you this kind of performance review. If they don’t, and certainly if they “won’t”, then maybe you should move on. After all, isn’t performance the whole point? Next time someone or some broker tells you they’re doing “great” in the market, you can ask them, “compared to what?” Listen to see if they fumble their answer. Now you’ll know what to listen for.

Ryan Investments (RI) is an SEC-registered investment advisory firm based in Aspen, Colorado serving individual investors and non-profits. Our strategy is called “iFolios®” – index fund portfolios actively managed for growth and protection. More information is available at www.ryaninvest.com or (970) 429-1100.