James Sweeney No Comments

“The expectations market is about speculation. The real market is about investing. The stock market, then, is a giant distraction to the business of investing.”

— John C. Bogle, The Little Book of Common Sense Investing


Today, let’s reflect on one of the most frequently asked questions I hear from investors:

“How am I doing so far?”

That’s a great question. And understandably, investors want to know if their portfolio is performing up to expectations. Unfortunately, investing in the stock market is more like taking a trip on an airplane – headed for the right destination, but constantly off course due to turbulence, inclement weather, etc. – than it is like taking a stroll around the block.

Market Volatility In Action

Consider three different short-term scenarios we encountered in 2020.

Portfolio #1: January 2020 thru October 2020

Last fall, a client asked how their portfolio had performed year to date. Through October their portfolio was basically flat for the year – neither gaining nor losing value.

Out of context, this might seem disappointing. Why invest if your money doesn’t grow? It’s understandable that 10 months with zero growth would be discouraging.

But remember, global markets had tumbled by more than 30% just a few months earlier. Anyone who panicked and exited the market in March probably also failed to get back into the market before a surprisingly rapid “V-shaped” recovery took off in April. These portfolios were probably nowhere near back on track by the end of October.

In that context, for those who stuck it out despite all the dire news, flat returns didn’t seem so bad.

Portfolio #1 (Continued): January 2020 thru November 2020

This client’s story doesn’t end there. He called me a month later about an unrelated issue and at the end of the call, asked again, “So how do we look year-to-date now?” I looked it up and told him that he was now up 10% year-to-date.

He was shocked. “How could that be,” he asked incredulously, “when just a month earlier I was flat for the year?”

That’s how strong November markets happened to be. This, even though many pundits were suggesting investors might want to sit out of the market during an incredibly raucous presidential election. Only in hindsight did we discover what a bad idea that would have been.

Portfolio #2: March 2020 thru January 2021

One more illustration. In March 2020, we happened to launch a new client’s portfolio during what turned out to be the market bottom. Since this particular portfolio started with SwitchPoint right at the bottom, when we reviewed his returns at year end, he couldn’t believe how well he had done.

Does this mean we’re market-timing geniuses? Of course not. When we built his portfolio, we did not know – nor did we try to guess – what the year ahead had in store. We built his portfolio according to his needs and tolerance for risk and it just so happened that the market rallied quickly after he moved his accounts to us.

What can we learn from these examples?

  1. The stock market is volatile. The stock market is an intricate system for pricing everything we know about public companies, every minute of every day. No matter if we are in the middle of a natural disaster, global pandemic, or political strife. Prices react to news quickly and sometimes dramatically – and sometimes in unexpected ways.
  2. Short-term focus is detrimental. Because the stock market doesn’t just move in a nice straight line, focusing on short-term performance will at best cause you anxiety and at worst it could cause you to deviate from your well-thought-out plan.
  3. Using arbitrary timeframes to judge your success (or the success of a potential investment) can lead to incorrect conclusions. The owner of Portfolio #1 could have used the timeframe of January – October of 2020 and concluded that his portfolio was no good. If he did, he would have missed the great returns in November and beyond. Likewise, the owner of Portfolio #2 could assume that his portfolio will continue to achieve returns of 30%+ every year going forward. This would be just as unwise.

This last point is the primary idea I want to drive home today.  It is so wired in our DNA to extrapolate past performance into the future. But it’s so misguided in investing.

Volatility Can Deceive

Let’s consider a few other more scenarios.

The 1-year return of S&P 500 index ending February 28, 2021 was 23.3% (not bad). However, the 1-year return ending March 31, 2021 (just 1 month later) was 60.8%! Why? The market crash from March of 2020 fell off the 1-year number. We’re talking about the same investment and almost the same timeframe, but it looks completely different. But I bet if someone gave you those numbers out of context, you would have completely different expectations about future returns.

Even longer periods can also be misleading. Consider the return on stocks from 2000 (at the height of the tech bubble) through 2010 (just removed from the Great Recession). The S&P 500 returned -1% per year during this period. What a horrible investment!

If you looked at that 10-year track record to make your decision about whether to invest in US stocks (and many did), you would have missed the next 10-year return from 2010 – 2020, which was over 13% per year!

Neither decade is fully representative of what we would expect for stocks to do in the “long-run”. If ten years isn’t long enough to gauge an investment’s merit, timeframes of a month, quarter or year are essentially worthless.

Shift Your Focus

Because of all of the above, past performance can be – and often is – used to manipulate and deceive. You can slice and dice performance to show whichever timeframe makes your results look great. We are constantly warned that “past performance is no guarantee of future results”, and yet, past performance is what 99% of the financial industry uses to sell investment products and strategies. Don’t fall for it!

To accurately answer “How am I doing so far?” we suggest connecting your portfolio’s performance to something far more durable than a month, a year, or even several years of performance.

  1. Time: Be prepared to look at long-term returns, probably at least a decade (but as I showed above, sometimes even that isn’t long enough!).
  2. Context: Be careful to compare your returns to an appropriate benchmark. Is your portfolio different from your neighbor’s, with higher or lower amounts of investment risk and expected returns? If so, expect it to perform differently than theirs over time, with different levels of volatility along the way.
  3. Goals: How do you decide how much market risk to accept in pursuit of higher returns? Measure that according to your personal, long-term goals, rather than the market’s near-term moods. If your situation calls for a higher risk/higher return portfolio, be prepared for larger drops at times. The success of your plan does not depend on avoiding every drop in the market, it depends on you capturing the long-term returns that markets generate.

This is a difficult task. Who can actually wait 10+ years to decide if their investment strategy is valid?

It’s All About Confidence

Let me go back to the airplane example. Going through what we went through in the stock market last March is like hitting some turbulence on a flight. Volatility is part of investing just like turbulence is part of flying.

When you’re sitting on an airplane going through turbulence, you just have to put your faith in the airplane (and the crew who prepped and inspected the plane) and in the pilot flying the plane. You know that despite the temporary discomfort, eventually you will get to your destination.

Likewise in investing, you are going to hit some turbulence – it’s not a question of if, but when. Turbulence does not mean you’ve got a bad strategy, it’s just part of the journey. But when you hit that turbulence, you need to have as much confidence in your advisor and in the overall strategy as you do in your pilot and airplane when you take a trip.

If you don’t, then find a way to get there. Ask questions. Do some homework. You may find that a change in advisor or a tweak to your investment strategy is necessary.

But I can promise you that if you get that confidence, it will become much easier to ignore the temporary turbulence of the market. And that will drastically reduce your anxiety and increase your odds of achieving your investment goals.