Why You Should Not Care if Your Portfolio Underperforms the S&P 500 Index 


Disclaimer: this is not to be construed as investment advice or a guarantee of investment return. I am not an investment advisor, registered with any investment entity or financial self-regulatory agency. If you disagree with anything in this piece - I don’t care. Don’t send me any email or comments to debate since I have better things to do like listen to music and read. If you use any of the material, just give me credit. On a personal note, drink more beer and read Flannery O’Connor - it’ll  make you a better person. 

So, the S&P Index touted a respectable 13.69% in 2014. How do I know this? Because it is talked about incessantly via the financial media. And when compared to a diversified portfolio (let’s say a moderate portfolio like the Vanguard 2035 Lifestyle fund) which returned 7.24%, you would think that diversification is a failed investment strategy that should be abandoned. 

So, let’s take a step back and look at the S&P 500 Index and see if it is an appropriate gauge (benchmark) to determine if our investment strategy is successful or not.

First of all, you can’t invest directly in an index. Granted there are S&P 500 funds (like iShares S&P 500 ETF - IVV) but there are costs--i.e., trading fees, bid-ask spread costs, expense ratios, etc. So the return of the index will differ from the actual fund since there are costs to manage the fund.

Secondly, the S&P 500 Index represents only ONE asset category. Prudent asset allocation strategies utilizes a global asset category allocation approach since global markets do not move in correlation with each other. Further, since asset categories have unique dimensions of risk and return, combining them in an asset allocation strategy can potentially enhance the returns and lower the standard deviation risk of the diversified portfolio.

Lastly, using the S&P 500 Index to compare your portfolio’s performance misses the mark since MOST portfolios are not singularly focused on the S&P 500. Most portfolios are comprised of various asset categories and not one specific asset class or fund. Thus, the most logical way to compare your portfolio’s performance is to take each investment component and compare it to its relative benchmark (size, style, etc)--not to compare it a generic index like the S&P 500 Index. This will give you a more complete picture and assessment whether or not what you are doing is prudent or not.

The chart below compares the S&P 500 Index and MSCI All Country World Index (USA excluded). As you can see - if we were to use the financial media’s methodology of talking about returns - we should consider the world index instead of the S&P 500 (*see chart below).  But one never hears about other indexes--what investors typically reference is either the S&P 500 Index or the NASDAQ. Both are known indexes but are irrelevant when doing a benchmark analysis of a diversified portfolio. 

*S&P 500 compared to MSCI All Country World Index (excl. USA)

*DFA Returns Software.  Investors can’t invest directly into index funds. Returns shown do not take into account any costs. Past performance not an indicator of future performance. This is not an investment advice.



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