By Scott Roark, MBA, PhD | April 20, 2019
There are plenty of circumstances in life where you really don’t want to compare yourself with others. Doing that is a fairly reliable way to make yourself feel bad – there will always be someone better looking, more athletic, more successful or richer than you. But in the world of investing, it is critical to compare the performance of your portfolio to a suitable benchmark. It gives you a sense of how well you are (or your investment advisor is) doing.
Comparing Yourself With Others
The trick in comparing investment performance is to ignore the headline number – absolute performance and instead focus on relative performance. Absolute performance is simply the return you had – maybe up 7% for the year, or down 4% for the quarter. Relative performance, on the other hand, compares your investment returns to a suitable benchmark. The key word there is “suitable” – something else that reflects the characteristics (risk, asset allocation, etc.) of your investment. So, you wouldn’t want to compare your bond portfolio or your High-Tech mutual fund to the S&P 500 – in both cases, the benchmark doesn’t reflect the nature of your investment.
There are some strange things that can happen when you start looking at relative performance. First, you can be upset when you have a “decent” absolute return. Perhaps your balanced mutual fund earned 5% for the quarter. But if the benchmark for balanced funds is 9%, it is perfectly reasonable to be upset with your “decent” return – you did worse than you should have given the characteristics of your investments.
Stranger still is the situation where you should be happy with a negative return. This would happen when your portfolio lost (for instance) 8% in value, but comparable investments lost 16%. If that situation occurs, you are fortunate indeed – even though your value went down.
Let’s Be Reasonable
At the end of the day, you want a return that is reasonable given the investments you have made – what is frequently termed the “risk-adjusted return”. If you are getting returns close (say within 1%) of an appropriate benchmark, you are doing pretty well. Unfortunately, many investors – after paying advisor fees, mutual fund fees, and other transaction costs are well below where they “should” be. And worse still, many of these investors don’t realize that fact. Next time you are reviewing the performance of your investments, make sure you compare those results to the results of comparable benchmarks.