Are You Outperforming the Market?

The Standard & Poor’s 500 index is soaring; rising over 17%!   Money managers, mutual funds, institutions, pension plans, endowments are all under pressure to beat the stock market.  A money manager who outperforms the index is a hero while one who underperforms is a goat.   Short-term index chasing returns might be good for the professional, not so for the individual.

The S&P 500 index is an unmanaged basket of 500 stocks and doesn’t assess fees.  A money manager charges a fee and it’s deducted from their gross return.  A money manager who’s up 17% and charges a 1% fee will see their return drop to 16%.  Because of the 1% fee, the money manager is underperforming the index. 

Let’s look at some history before you sell your diversified portfolio and invest it all in a S&P 500 index fund.  From 2000 to 2010 the S&P 500 lost 9.1%.   A $10,000 invest in January of 2000 was worth $9,090 by the end of the decade.   You lost during the “lost” decade.   

Do you need to outperform the stock market?  It’d be great to beat the market every year but it’s not necessary to achieve your financial goals.   The ultimate index to follow is your own.  A financial plan will give you the best metrics to track.  It’s more important to achieve your financial goals than it is to outperform the stock market.

Let’s look at a few examples. 

·         Your goal is to retire with $1,000,000 so you can live comfortably for the rest of your life.  After completing your financial plan, you realize your assets are worth $2,000,000.  Your current assets are more than enough to allow you to retire in style.  In this scenario, you need to preserve assets not outperform the stock market.   A mix of cash, bonds and a few stocks will help you achieve this goal.

·         Your goal is to retire with $1,000,000.  Your current assets are $250,000.  If you save $10,000 per year, for 20 years you’ll achieve your goal with a 5% return.  The stock market has averaged 7.35% for the past twenty years.[1]   If you achieved your million-dollar goal, would you be upset if you didn’t outperform the stock market?  A portfolio of stocks is recommended for this goal.

·         You need $50,000 in annual income to maintain your lifestyle.  If your investment portfolio generates $60,000 per year income, your goal should be to maintain the income and not outperform the stock market.  A portfolio of bonds and dividend (growing) paying stocks will be needed here.

Investors have two primary fears according to a study conducted by Dimensional Fund Advisors.  The first is not having enough money for a comfortable retirement and the second is a significant drop in the stock market.[2]   If you avoided these two pitfalls, does it matter if you didn’t outperform the stock market? 

Focus on your goals and not the stock market.  A diversified portfolio of stocks, bonds and cash will treat you well over your lifetime.  Stay diversified my friends!

Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it.  ~ Peter Lynch

Bill Parrott is the President and CEO of Parrott Wealth Management.  For more information on financial planning and investment management, please visit www.parrottwealth.com

June 6, 2017

[1] Morningstar Office Hypothetical Tool.

[2] 2017-Dimensional Fund Advisor Investor Feedback Survey.