There are many problems with benchmarking, but one of the worst is called “comparison envy.”
Comparisons in the financial arena is the main reason clients are unable to stick with a process they are comfortable with and that works for them. They get side-tracked by some comparison along the way and lose their focus.
For example - If you tell an investor they made 12% on their portfolio, they are very pleased. If you subsequently tell them that ‘everyone else’ made 14%, you have made them upset.
Here is a little secret about large institutions in the financial services industry. They push these index comparisons to make people upset so that they will move their money around in a frenzy. Money in motion creates fees and commissions. The creation of more and more benchmarks is nothing more than the formation of more things to compare to, allowing clients to always feel like they are missing out.
Comparing your performance to an index is not only useless – but it is also potentially the most dangerous thing you can do as an investor.
Trying to “beat an index” requires investors take on substantially more risk than they realize. Oh, and guess what? If you start falling behind – even higher levels of risk are necessary to try and make up the difference! This cycle creates mistakes that cost investors dearly.
The need to compare is actually a psychological need and the “need to win” leads us into making decisions that ultimately have a cost. Wall Street uses this behavior by creating benchmarks to give you something to chase.
Like a greyhound at the race track chasing the mechanical rabbit. The dog will never catch it, but he tries every time the gates open.
However, in this case, the thing we are trying to beat – an Index - is an illusion. They are devoid of the aspects of real portfolios like:
- The index contains no cash.
- It has no life expectancy requirements – but you do.
- It does not take distributions to meet living requirements – but you do.
- It requires you to take on excess risk and potential for loss to get equal performance – this is fine on the way up, but not on the way down.
- It has no taxes, costs or other expenses associated with it – but you do.
- It benefits from share buybacks – but you don’t.
To win the long-term investing game, you must build your portfolio around the things that matter most to you.
- Capital preservation
- A rate of return sufficient to keep pace with inflation.
- Expectations based on realistic objectives.
- Higher rates of return require an exponential increase in the underlying risk profile.
- You can replace lost capital – but you can’t replace lost time. Time is a precious commodity that you cannot afford to waste.
- Portfolios are time-frame specific.
Also, we are supposed to be long-term investors, which suggests that we should focus on the long-term results, and not short-term deviations.
Bottom line, indexes are illusions and chasing them takes your focus off of what is most important – your money and specific goals. Investing is not a competition, some years you will win, and some you will lose, but a long-term investment discipline will win over time.
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security.