First step in measuring: define your terms
Often when we enter a new year we look back upon the previous one and measure how we did. Whether this is good for your psyche or not, I’ll leave up to the psychiatrists. But is it good for your investments?
Before I address the good or bad of comparing your investment portfolio to the market, I think I’d like to begin with a more basic question: What is “the market”?
How you coming with that answer?
Usually, when I say “the market” what I mean (and I believe you think) is the stock market. Why? There are a whole lot more markets out there than the stock market. There is the bond market, the real estate market, the commodities market, and the supermarket. Why do we only think about stocks?
If you were going to sell your house, what’s more important, the stock market or the real estate market? For you smarties out there, yes I’ll admit that the stock market can influence the real estate market, but which is more directly related to your home’s value?
Here’s another point. Is it the real estate market that is most closely tied to the price of your abode, or is it the housing market? Do you really care about the changes in mall valuations, apartment complexes, storage units, hospitals, or office buildings? No, you care mostly about what’s been happening in single-family residential housing.
Even when you have it more closely identified you’re not done. Knowing the housing prices in Santa Ana, California or Ballston Spa, New York or Kalispell, Montana doesn’t really help you figure out whether it is a sellers’ or a buyers’ market in Iowa Park, Texas.
Then why do most people think that “the market” is the stock market and “the market” is the primary driver of their personal investments? It might be, but likely it is a less than perfect measure of how individuals are doing. The two most quoted measures of stock market performance are the S&P 500 and the Dow Jones Industrial Average. Those might be good measure if 100% of your investments are in large stocks of companies domiciled in the United States, otherwise, it doesn’t tell the whole story.
Even if you are investing in large US stocks, the sectors that you invest in may be different than the weightings of the sectors of the indexes. You may have worked for a telecommunications company and all of your stock is with one of the AT&T relatives. Maybe you’re in the energy industry and you’ve accumulated stocks there. Perhaps you’ve been enamored with technology and your portfolio is stacked with tech companies. In that case the performance of your portfolio is going to be very different than that of “the market.”
Now that we’ve defined “the market,” how do you decide if you’ve done better or worse than average? I’ll introduce average next week.
This article was published in the Wichita Falls Times Record News on January 11, 2015.