Benchmarks May Not Be a Helpful Guide
Making investment decisions based on a “benchmark” can lead to under-performance, ill-timed decisions, knee-jerk reactions, and excessive risk.
For most investors, the common benchmark is the S&P 500 index, often due to simply being widely recognized.
However, most investors do not own anything similar to this index that is only 500 companies.
Most investors own mutual funds and Exchange Traded Funds that make up 1000 or more holdings in their portfolio. (As a result, investors are over-diversified. More on this another time.)
Additionally, the S&P 500 index has an over-weight to the famous FAANG+M stocks – Facebook, Amazon, Apple, Netflix, Google, and Microsoft.
Being overly concentrated to a single stock is dangerous, but even more so when “most” are doing it – professional advisors and do-it-yourself investors alike.
The challenge for most investors is that they too are overly concentrated to these same six stocks but are concentrated through mutual funds and ETFs, making de-concentration very difficult because it would mean an overhaul of their portfolio allocation.
Here are the additional dangers with using this index (or any benchmark) for making investment decisions:
- It can force a managed portfolio to have the exact company and industry weights of the holdings of the benchmark being used.
- It can lead advisors and investors to make short-term knee-jerk reactions about their portfolio when their portfolio deviates in performance from the benchmark.
- It can influence portfolio managers to chase a return in an effort to out-perform the benchmark.
- Finally, it can lead to holding concentrated positions in the portfolio in order to remain aligned with the index (like the S&P 500) or benchmark and hold on to a winning stock for too long.
The better benchmark is your financial purpose, goals, lifestyle needs, legacy desires, and desired peace of mind about your money.
Do you know what you want?
And are your investments aligned with what you want?
These are among the critical things that matter the most in investing.
Quote:
“No rule always works, the environment isn’t controllable, and circumstances rarely repeat exactly. Psychology plays a major role in markets, and because it’s highly variable, cause-and-effect relationships aren’t reliable.”
– Howard Marks