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Why Didn't My Portfolio Beat the S&P 500?

If you are a regular subscriber to news about the markets, you probably hear a lot about the performance of the Dow and the S&P 500. Between performance and speculation, the U.S. markets almost always seem to be “having a moment” if you follow the news coverage.

All that exposure leads to comparison, and I often have clients who measure the performance of their personal portfolio against what’s happening in the U.S. markets, which people typically think of as the Dow and S&P. In conversations, some ask – if the S&P 500 is doing so well – why isn’t my portfolio performing better (or at least as well as the S&P)?

First, let’s define “markets.” The Dow and S&P are just two of many different types of markets and ways to invest, and both are located in the U.S. The Dow Jones Industrial Average is the second oldest stock index (and as this link indicates, “is a pretty useless index with regard to tracking the health of the U.S. stock market). It tracks the value of 30 large, publicly traded companies, chosen by S&P Dow Jones Indices, with no specific rules for inclusion. The S&P 500 is an index of 500 large, publicly traded American stocks. To be included in the S&P 500, a stock must have a market capitalization of $8.2 billion, a public “float” (the number of shares that can be bought and sold by the public) of at least 50 percent, positive earnings for the most recent four quarters, and adequate liquidity as measured by price and volume. In addition, the companies that make up the S&P 500 change on a regular basis.

Better Investment Experience

It would make (more) sense to use the S&P 500 as a portfolio benchmark IF your portfolio consisted only of large-cap American stocks. However, if you are a client of AMDG Financial, your portfolio likely includes investments outside the U.S., as well as a tilt toward smaller-cap and value stocks, which doesn’t support an apples to apples comparison. We invest our clients the way we do because of rigorous academic research pioneered by Eugene Fama, a Nobel Prize winner, Kenneth French, and other giants in investment, as well as financial research by Dimensional Fund Advisors (DFA). Their research shows that smaller and lower-priced value stocks have higher risks and greater expected returns over larger, higher-priced growth stocks over longer periods of time. We believe that DFA’s funds in client investment strategy delivers an outstanding investment experience in support of our clients’ financial objectives over time, compared to their mutual fund competitors and relevant benchmarks. (As an aside, AMDG Financial uses Dimensional funds because we believe that when taking into account DFA’s investment factors, low fees, tax-efficiency and data-driven strategy, the company offers our clients the best overall investment solution. We do not receive fees or commissions from DFA and have no sales relationship.)

Diversification also plays an important role. If your portfolio mirrored the S&P 500 exactly, it would contain only U.S. stocks from publicly traded companies that have large market capitalizations. But don’t forget that while the U.S. has the largest percentage of market capitalization in the world, investing ONLY in the U.S. would prevent you from taking advantage of opportunities in other established and emerging markets, which – as you can see in the chart below – make up the other 46% of the world’s market cap. Investing globally, and in different allocations, helps you stay diversified, lowering your risk of exposure to one over-weighted asset class.

The Case for Global Diversification - Unbranded

Source: Dimensional Fund Advisors

In addition, diversification can be a handy hedge against the randomness of returns. If you look at the equity returns of developed markets, it’s hard to see a pattern of performance by any one market. The table below ranks annual stock market performance in U.S. dollar terms for 22 different global markets (from highest to lowest) over the past 20 years. The patchwork dispersion of colors shows no predictable pattern. Investors who follow a structured, diversified strategy that includes periodic rebalancing are more likely to capture the returns wherever they happen to occur in markets around the world. Note that the U.S. led in 2014, but came in tenth in 2015, sixth in 2016, 16th in 2017, and third in 2018.

Based on these returns, can you predict how the U.S. will perform this year? OK, trick question – no one can, and that’s my point. Indices can only show you the historical data; they cannot help you predict the future. There’s no pattern in the chart below. Because we can’t tell you how the markets will perform, our strategy is to create a portfolio in which – at any given point – investments that are doing well will help to offset those that are underperforming and provide an opportunity to rebalance. If your portfolio tracked the index exactly, you would experience the same extreme highs and lows as the market, making for a much more volatile investing experience.

PeriodicchartSource: Dimensional Fund Advisors

Are You Goal Driven or Performance Driven?

At the start of our relationship with our clients, we always ask about your goals. What do you hope to achieve with your investments? Are you looking to start or expand a business, put your kids through college, or save for retirement? We draw on the lessons of Modern Portfolio Theory to help you determine a portfolio that supports the level of expected return needed to achieve all that is important for you, with lower overall risk, and work toward meeting or exceeding your goals – not meeting or exceeding an arbitrary benchmark. We tend to invest our clients’ money to achieve an expected rate of return that exposes them to equity and fixed income risk that is more measured and prudent than they would experience if their portfolios only contained equities; something that a focus on performance does not provide.

Instead of focusing on performance, the right question to ask is whether you have the proper mix of investments to meet your goals, rather than whether your portfolio is matching or exceeding a benchmark like the S&P 500, which likely doesn’t mirror your investments.

It’s easy to get caught up in tracking the S&P 500, the Dow or other indices, because the U.S. media tends to focus on the U.S. markets in its reporting. We also include the S&P 500, along with other indices, in our quarterly reporting to you as a reference. However, none of the indices in the report will be an exact match to your investments, so don’t expect to be able to make a direct comparison with any index. Instead, use those indices to gauge the overall health of the global markets and to learn more about the underlying assets in each. If you would like to find a benchmark that’s more representative of your portfolio, we can help you create one – just contact us or bring it up at your next checkpoint meeting. We love helping you understand how portfolio design works, as well as helping you accurately track progress toward your goals!

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