Almost every day, someone makes millions investing in the lottery. Others have preserved treasure in their back yard. Most of us have an emotional tolerance for risk between these extremes, and we tend to believe that the appropriate risk level is called "the Market" –– and that our portfolios should always perform somewhat better than "the Market."
The most common expression of "the Market" is the S&P 500, an index made up of 500 stocks. Investors constantly measure their performance against this artificial benchmark, which, by the way, changes as stocks are cut or added to the index. The Market becomes imprinted in our minds, and, if our portfolio underperforms, we are overtly disappointed.
The problem with tying your portfolio to the Market is the benchmark itself. In 1999, the S&P peaked at 1498 before crashing to 815 in 2002. Then it went to 1503 in 2007, crashed to 667 in 2009, and returned to 1328 as I write this. Is that really a performance that you want to emulate? The broad U.S. "market" has behaved whimsically over the last decade while the world has continued to develop around us. There have been hiccups and saw tooth patterns along the way, but investing in the megatrends of improving global economies have richly served those who globally diversified their portfolios.
Almost astonishingly, many nations have shown less of an interest in destroying themselves and their enemies than in building better lives for people. The relatively peaceful transition of power in Egypt (so far) may prove to be another example of people who want to build a better society for themselves and their children. And in places like Singapore, Hong Kong, Malaysia, and China, people have created vast amounts of new wealth in which many Americans have participated by investing there.
Here’s the point: the "Market" –– the 500 representative stocks in the S&P index –– does not reflect world-wide trends or the timing of those trends. A diversified portfolio should include a large number of holdings that are not highly correlated to the Market so that you can outperform the market over a long period of time, not a short interval. This is why many aggressive, diversified portfolios include asset classes or sectors such as: precious metals, global energy, global food, global technology, Latin America, the Asian Tigers, China, India, the Nordic countries, and Canada.
It’s not unusual for investors to measure their financial advisor against short term performances of the S&P 500, despite the fact that in many cases 40-80% of their holdings are not invested in large U.S. stocks. The purpose of diversification is to have a low correlation to the market … not to duplicate it.
What’s the take away? If your financial advisor has provided you with a diversified portfolio, measure that portfolio against the standard of your financial objectives. Also, factor in whether the overall volatility of the portfolio is relatively low. This can best be accomplished by having a number of low correlated assets that provide stability as each underlying holding moves up or down independently. Ultimately, the only thing that matters is whether your portfolio meets your financial goals and emotional needs. Whether it outperforms or underperforms the Market in a short time frame is not only irrelevant, but counterproductive to your long-term interest.
If you want to outperform the S&P 500, simply buy the Dow Jones Industrial Average –– but be aware that over the last 10 years, this large cap index of 30 U.S. stocks earned in total just 2.5%.
If, like me, you believe the world is changing and growing beyond our old benchmarks, and you want a diversified portfolio of global investments then it must include global holdings.
The performance data quoted represents past performance and does not guarantee future results.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which Investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
Bill Sheehy is owner of Sheehy Associates Inc., which specializes in Retirement Planning for individuals and corporate 401(k) plans. He is a Certified Financial Planner, a Certified Employee Benefits Specialist, a Certified Fund Specialist and a Chartered Retirement Plan Specialist. He can be reached at firstname.lastname@example.org or by calling 609-586-9100.
Sheehy Associates. 3812-B Quakerbridge Road, Suite 208, Hamilton. 609-586-9100. email@example.com
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