When searching for the day's financial news, you'll frequently come across daily performance reports for well-known indexes such as the S&P 500 or the Dow Jones. Many individuals will compare their portfolio's performance to these indices. While such indexes are popular because they seem to provide a snapshot of the market, they aren't always good benchmarks for assessing the performance of a specific portfolio. There are many reasons behind this, and we'll go through a few of them, so you don't fall victim to this harmful benchmarking habit.
It Doesn’t Give the Whole Picture
Indexes are frequently used by the media to determine market performance. In the news, we frequently hear about the S&P 500. The S&P 500 is a list of the 500 largest publicly listed corporations in the United States. It is important to know that the S&P 500 index companies are weighted by market capitalization, rather than equal weight. This means that the bigger the company is, the more impact its price movement affects the index value. Currently, five big technology companies make up nearly 25% of the index value. The roughly 3,000 firms that trade on public exchanges in the United States are not sufficiently represented by these indices. A properly allocated portfolio will have many more sectors and components than a narrow index, setting up an apples to orange type comparison.
It Takes Your Eye Off Your Goals
Matching the returns of a benchmark, such as the S&P 500, might not be the best path to achieving your personal financial goal. A financial plan often has competing needs consisting of both short and long-term goals. Using a common index as a benchmark would provide little value in determining how successful you are in achieving each of these goals. Most people want their financial plan to achieve their goals with the highest probability of success. The plan could be exposed to risks that decrease the likelihood of investor success by trying to match an aggressive benchmark return. If you are going to use a benchmark to judge your investment results, you should evaluate your investments in comparison to your own peer group. It is not alike comparison to judge an international manager’s returns versus a domestic manager or the results of a bond portfolio.
It Leads to Destructive Emotional Decisions
According to behavioral finance studies conducted by Dalbar Inc., investors fear losing money more than they enjoy gaining money. Because they are afraid of underperforming the market, many investors focus their attention on stock market benchmarks such as the S&P 500 to assess their own investing success. This is a particularly harmful habit to adopt since the fear of losing money frequently leads to damaging emotional reactions when the market tides change. For instance, in 2008, the S&P 500 lost nearly half of its value. Many investors realized their appetite for risk was not as large as the index they were following. To be successful, an investor needs to build a portfolio that takes into account their tolerance to volatility and time horizon to their goals.
What Should You Do Instead?
Many people make the error of investing without a well-thought-out financial goal and a good investment strategy to attain it. Their investment decisions are more likely to be market- or risk-driven than goal-driven, which leads to knee-jerk reactions and second-guessing, neither of which is favorable to consistent, long-term performance. To reach your financial goals you need a strategy based on your investment goals, desires, objectives, and tolerance for risk because they are the only benchmarks that matter. Big index fund benchmarks don't help you achieve your investing objectives. Only a well-thought-out investing strategy can do that.
Schedule A Consultation with an Experienced Financial Advisor
Here at Fourth Avenue Financial, our first priority is your overall financial success. We want to help you develop, implement, and monitor a strategy designed to address your individual situation to ensure all your investments are setting you up for a path of financial success. If you are ready to start planning for your financial future, we are here to help. Contact us today at (304) 746 7977 to schedule a meeting with one of our experienced financial advisors or schedule online: https://calendly.com/fourthavenuefinancial/introductory-zoom.
Securities offered through J.W. Cole Financial, Inc. (JWC) Member FINRA / SIPC. Advisory Services offered through J.W. Cole Advisors, Inc. (JWCA). Fourth Avenue Financial and JWC/ JWCA are unaffiliated entities.