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Obsession with the S&P 500 “The Market” can be bad for your mental health.

| June 04, 2015
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By: TrestleBridge Team Member, Tim Higgins

In a recent meeting I was discussing a client’s portfolio allocation and how his mix of different asset classes provided a significant level of diversification.  The client followed everything that I was saying and even pointed out how well (relatively) his portfolio held up during 2008 at the onset of the financial crisis and ensuing drop in the equity markets.  No more than 10 seconds later he expressed his disappointment that his portfolio had not kept up with the performance of the S&P 500 index in 2014.

I then reminded him that investing is like a baseball game whereby it is impossible to “win” every inning, no team can do that.  However, as long as you get consistent returns and do not “blow up” in any one inning (or year, in the case of the market) then you will most likely come out ahead and win the game. 

The client was nodding as I made this point, but what struck me was that I was talking to a stone wall.  My words were not sinking in or resonating with him as if a magical spell was clouding his thinking.  It was clear to me that his only concern was beating the market every single year for the rest of his life, whether that has any relevance to his real life or not. 

By the way, if you too share this obsession, let me ask you a question: would you be happy with a -36% return in 2008? If not, why not?  Because that return beat the market.  If -36% is not satisfactory to you, then for your own sanity, please stop obsessing about outperforming the S&P 500. 

On one hand, this discussion left me frustrated knowing that given this client’s stated risk tolerance, his current, diversified portfolio was much more appropriate for him than simply owning the S&P 500 index.  At the same time I was fascinated with his believe system and desire to consistently compare his portfolio to the S&P 500.  This isn’t new, I have seen this “obsession spell” with the S&P numerous times, but this particular conversation led me to write this post.

Again, why would someone dismiss their well-diversified long-term investment portfolio simply because it failed to outperform the market every year?  Is this a smart line of analysis?  If it’s not, who or what is to blame?

I blame the media.  On the nightly news (literally every night) the anchors report on the daily performance of the S&P 500, Dow Jones Industrial Average, and Nasdaq stock indexes, as if this is an all-inclusive view of the equity markets and as if they were all so unique and different from one another.  However, that is not all there is (as I address below) and they are not all that different, as they are all primarily large cap U.S. centric stock indexes.  Being all of the same type (or asset class) means that if one these index moves, typically they all move – in unison.  *Note: over the past decade the S&P is 97% correlated with the Dow Jones and 90% with the Nasdaq indexes (Source: iShares Correlation Calculator).  This type of reporting causes us (as viewers) to then focus (and obsess) on this one asset class: large cap U.S. stocks.  My thesis: this may not be a productive use of our attention and energy.

 

For the news to only report on these three indexes I believe is doing the audience a disservice and provides little value.  This is analogous to wanting a weather report for the continental U.S., but only getting updated reports from three cities close to each other, like Boston, Worcester, and Springfield (for MA residents).  They are most likely all going to report similar conditions.  What is the point?

 

Is your obsession with “the market” even relevant?

Would you agree that a 100% U.S. large cap stock portfolio like the S&P 500 is aggressive?  On a scale of 1 (being conservative/cash) to 10 being aggressive, you would have to put a portfolio invested 100% in the S&P 500 in the 8 – 10 range.  Yet, the vast majority of people (that I talk to) when questioned about their risk tolerance, indicate that they are NOT in the aggressive (8 to 10) range and/or would not want to relive the negative declines of the market that we have witnessed in recent history.  Therefore, if you are not aggressive, why would you consider comparing yourself to this benchmark?  If you do, you are only going to be disappointed.  There isn’t a portfolio that will always outperform the S&P 500 index every single year.  As a friendly challenge - if you find one let me know.

Don’t compare apples to oranges + bananas + pineapples + grapes + plums

Do you believe in diversification?  Most people know they should.  That characteristically means a multi-asset (multi-market) portfolio.  What are asset classes? Large, mid, and small stocks (U.S. and internationally based), emerging markets, real estate, commodities, domestic and foreign bonds, currencies, just to name a few.  Diversification (again) inherently means you have a mix of many asset classes, many markets, not just one.  In theory, a diversified portfolio can produce less volatile returns than just owning one aggressive asset class.  For most people this is appealing, but it also means that there will be years (like recent ones, as opposed to the early 2000s) when one of the best performing asset classes is Large Cap U.S. Stocks.  Therefore, if you are comparing your portfolio to “the market” or just large cap U.S. stocks, you most likely have snapshots in time where you will be disappointed.  I wouldn’t recommend doing this, there is no point.  You are just subjecting yourself to a cruel form of mental torture.

The problem: Mental torture leads to emotional triggers, which lead to emotional portfolio decisions, which lead to chasing returns and long-term underperformance (reported on many times by research firm Dalbar). 

A Healthier Outlook: Know that in a diversified portfolio you have some exposure to large cap U.S. stocks.  If “the market” is up, a portion of your portfolio is as well.  If “the market” is down, (only) a portion of your portfolio will be as well.  In addition, instead of using the S&P 500 as your portfolio benchmark, use well-diversified asset allocation fund (conservative through aggressive).

In Sum: Diversify, and tailor your portfolio to your risk tolerance.  Stop comparing yourself to just one aggressive asset class, it is not a productive activity. You will only get yourself worked up and very little good comes from that.  One of the conclusions I have come to over my career is that people are emotional beings and we are best served by implementing (to the best of our ability) systematic, unemotional portfolio management systems.

Again, try to avoid the “obsession with the market spell,” because it will cloud your vision and challenge your sanity.

There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Stock investing involves risk including loss of principal. No strategy assures success or protects against loss.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The experience described here may not be representative of any future experience of our clients, and should not be considered a recommendation of the advisor's services or abilities. Individual results will vary. Past performance is no guarantee of future results.

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