INVESTING WITH CLARITY™ BLOG

Don't Let Stock Market Indexes Fool You!

March 5, 2012 9:07:00 AM

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The investor's chief problem - and even his worst enemy - is likely to be himself.

- Benjaman Graham

As 2011 came to a close, many experts in the financial services business have discussed the difficulty 2011 was for money managers and investors.

One of the many difficulties for investors to understand was the disconnect between U.S. index performance (S&P 500 and the DJIA) and the portfolio performance for many investors.

Why the disconnect?

There are several reasons.

First and most important, as I have written for many years, we are not fans of benchmarking portfolios to an index. This, of course in counter-intuitive to what investors have historically learned.

Why are we not fans of benchmarking?

It is simple. First, we believe the key to successful investing is the process of owning usinesses\, not the stock market over time. Therefore, short-term performance of an index should not be important to a long-term investor. The quality of the businesses you own should be more important!

Second, most investors use benchmarks to grade or compare the performance of their portfolio.

Is there a problem with that process? Absolutely!

Why? because, investors do not realize that in most cases, they are comparing apples to oranges. For example, why were many portfolios down last year while the S&P 500 and DJIA were up?

Because most investors DO NOT have 100% of their assets invested in the companies which make up the S&P 500 and the DJIA. Many investors have investments in Emerging Markets, Europe and other International markets. So, to compare one's portfolio to the U.S. indexes would be inappropriate.

Third, most investors do not know or understand how indexes work and what companies make up the performance of a given index. For example, Apple Computer made up 44.5% of the Nasdaq's total return in 2010! In fact, recently, in the middle of the trading day, the Nasdaq was up 1% intraday. That would be exciting and great news for some. However, the reality is, .90% of the 1% came from Apple stock alone!!!

In fact, an article published on Yahoo Finance on January 3, 2011, showed, in 2010, ten companies made up over 25% of the S&P 500's total return.

Since the S&P 500 bottomed on March 9, 2009, twenty-seven (27) companies have made up over 57% of the total return as of February 23, 2012. I think that is amazing!

Think about it- Only 27 companies made up over 50% to the indexes total return. The largest? Apple at 12.57%.

Benchmarking is a problem for investors because many do not know how index returns are calculated. Frankly, many investors do not know what is owned in an index.

How can one know they are accurately gauging the performance of their portfolio appropriately when in many cases they not only don't know how an index is calculated, they don't even know what they own in their own portfolio!!!?

Don't let stock market indexes fool you! Understand the isk (including the philosophy and strategy) you are taking in your portfolio to achieve the long-term eturns.

Invest with Clarity.

 

 


Mark Pearson

Mark Pearson

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