Déjà vu all over again. We have been here before, specifically in 2011. I am referencing a debt...
Why Benchmarking Against the S&P is a Losing Proposition
It is common for investors to follow large stock market indexes such as the S&P 500 (GSPC) and the Dow Jones Industrial Average (DJI) as a standard to measure the expected returns of their portfolio. These indexes are typically highlighted on financial TV shows and are on the homepage of nearly every financial news website. With this level of exposure, following these indexes becomes the easiest way to benchmark expected investment returns on a regular basis.
While these indexes do provide insight into the performance of large cap stocks, investors need to understand the reasons why performance of the S&P 500 and Dow Jones Industrial Average are not a proper measure of how an investment portfolio should perform.
The index contains no cash – nearly all investment portfolios contain some amount of cash readily available for a potential buying opportunity.
The index has no time horizon – investment time horizon is important to manage risk because you don’t want to take a big loss right before you are going to need the investments proceeds.
The index does not provide income – some investment portfolios are used to generate income for living expenses. Managing high level of income and withdrawals has potential to add more cash to a portfolio than normal and drag down returns.
It has no taxes, trade costs, or other expenses associated with it
It can result in taking excess risk – the S&P 500 and Dow Jones Industrial Average indexes are a good benchmark for large cap stocks, one of many asset classes in a diversified portfolio. If an investor is chasing returns of these indexes this may cause them to over-concentrate their portfolio in one area and potentially subject their investments to significant risk. Over the past few years, since 2013, we have seen a period in which the S&P 500 has outperformed nearly every other asset class each year. This extraordinary run cannot continue forever and relying on such a short sample size to make investment decisions can be dangerous. At Virtus Wealth Management we believe in maintaining a diversified portfolio consisting of various asset classes including stocks, bonds, international, and alternative investments such as real estate and hedge strategies. This level of diversification is used to try to manage downside risk over the long term and to match an investor’s risk tolerance level with portfolio risk.
Measuring investment performance versus a benchmark is difficult. Investors need to be cautious of trying to compare a diversified portfolio with a concentrated index. Try to look at a variety of indexes that cover multiple asset classes and perhaps even a blended benchmark that takes into account diversification. As with every aspect of investing, one must consider the risk they are taking or are willing to take when trying to determine expected returns. At Virtus Wealth Management we have tools to help measure the risk you may be willing to take and match that against the risk you are currently taking to make sure you and your portfolio are on the same page. To learn more about these tools and to better understand the risk in your portfolio feel free to call us at our Southlake (817-717-3812) or Arlington (817-795-1095) offices.