When it's best to bench the benchmarks

Today I’m wrapping up a series that looked at examining how well you did compared to the market last year. First we determined that the “market” doesn’t contain the same mix of investments in your personal portfolio, so it’s not what you should measure yourself against. Instead, I introduced the Morningstar® Moderate Target Risk Index which I thought was a better measure than an all-stock index like the S&P 500. An index or other measure you compare yourself to is called a benchmark. This column discusses measuring your own performance against various benchmarks, such as that Moderate index, the S&P 500, or the “some-dude-you-know” benchmark.

When we measure how you did in 2014 vs. one of the above, you will either have done better or done worse. If you did better you are probably happy, if worse, you’re probably sad. But last week I also mentioned that it doesn’t make sense to measure yourself against a benchmark that you don’t want to follow. If you are not interested in keeping 100% of your money in stocks, then you shouldn’t measure the performance of your investments against a stock measure.

That’s why I wanted to measure against sometime a bit more realistic like the Morningstar® Moderate Target Risk Index. But even that only works if your investment strategy is to invest globally with about half- to two-thirds of your money in stocks. If not, find an index that more closely matches the type of investor you are. (For example, there are four other Risk Indexes from Morningstar® and hundreds of other indexes out there.)

Still, you may do yourself a disservice. That’s because being beat by an index does not mean you did anything wrong. Go and find whomever you think is the most perfect investor in the world. Maybe that’s a mutual fund manager or someone like a Warren Buffet.  Maybe it’s your cousin. Then examine how they did across the years. Trust me, you’ll find that quite often they don’t do all that well. That is because no strategy, tactic, or crystal ball works perfectly. Neither will you.

So a question you have to ask yourself if you look bad compared to your chosen benchmark: Is this because of a season or a flaw? If a season then it’s just that your strategy is temporarily out-of-favor. If it’s a flaw you need to change how you are investing. How to tell the difference? Sorry—we professionals haven’t figured that out either. Time will tell, but since you don’t have decades to test a strategy you’ll instead have to spend some time (no, a weekend won’t cut it) to learn how the markets work and how you fit in them.

If that’s a hobby that sounds appealing to you, then I welcome you to the fold. If not, all is not lost. You can hire it out (which makes me happy…though I do admit a certain amount of bias there), or invest in a way that does most of the work for you: buy a global asset allocation fund. That way, you leave the “market comparisons” to the experts.

This article was published under the title "Be careful measuring success" in the Wichita Falls Times Record News on January 26, 2015.