Something troubling about investors in recent years is the fixation on comparing their globally diversified portfolios’ performance to the S&P 500. Whether it should be or not, the S&P 500 has become a standard portfolio measure for all other portfolios.
That said, investors may not understand what the S&P 500 is—an index that tracks the performance of a collection of the 500 largest companies in the United States. Also, investors often give too much attention to the S&P 500 because that’s what they hear from the media. Every day, investors are alerted by finance “gurus” and reporters that the S&P 500 is up or down.
If our emotions are fragile, the S&P 500 can be a sledgehammer. It shouldn’t be misunderstood that the index is essential. The S&P 500 can be used as a barometer for economic health or market direction. The index, however, is a poor benchmark for investors that have a portfolio with exposure outside of US large stocks. Investors must understand that you can’t compare apples to oranges.
It’s interesting and sometimes eye-opening to consider that the United States only holds about 54% of the world’s global market capitalization. You may have heard of companies like Nokia, Spotify, Toyota, Honda, Sony, and other established non-US companies listed on the New York Stock Exchange.
Our memories are often short when it comes to the financial markets. For example, we have forgotten that US stock hasn’t consistently outperformed international stock. This is primarily because US stock has outperformed international stock by 275% in the last fourteen years.
Fourteen years with such outperformance has led investors to believe that this is how it has always been. US stock is the “stock market.” Turning the clock back even just to 1971 would show nine periods where international stock and US stock took turns outperforming each other. For example, during the ’80s, international stock outperformed US stock by 374% for six years.
The pattern emerges that international stock and US stock alternate and negatively correlate. Following this cycle means that US stock has outperformed international stock for an unusually long time. However, some financial professionals anticipate that the narrative will soon change and that international stock could begin to top US stock.
Yes, indeed, past performance doesn’t guarantee future results, and it is possible that international stock never rebounds and US stock continues to outperform international stock for the foreseeable future. But it doesn’t seem probable.
You may have heard the saying that “the only thing in this life that is certain is uncertainty.” Markets are uncertain, especially in the short term. We do see patterns in the financial markets, however. These patterns emerge over the long term. Mark Twain authored the famous phrase, “History doesn’t repeat itself, but it often rhymes.” The market under a magnifying glass would look quite similar to the market in its entire history.
Understanding this is crucial for investors, especially when the media bombards us with information. But unfortunately, the average investor sells when stocks are half-off and buys when stocks are selling for a premium. That means that the average investor is playing a losing game.
When it comes to your life savings, giving in to the media and your emotions could be disastrous. Missing even just the ten best days of a 20-year investing period could mean your return being cut in half. Realize that more often than not, the best periods are within days or weeks of the worst periods.
Investors should be rooted in the belief that knowledge is power. Therefore, it is crucial to understand benchmarks such as the S&P 500 and what they mean to your portfolio. If an investor had a diversified portfolio, for example, and heard on the radio that now is the time to get out of the market before it’s too late, they may be tempted to sell.
Then suppose this investor sees that the S&P 500 is down significantly. Imagine their neighbors and coworkers have sold most of their investments because “this time is different.” The story is always different, but the narrative is always the same. In this scenario, the above-average investor would have the power to hold on despite the news. It might be hard to avoid the temptation and give into emotion, but their knowledge of the markets helps them make informed and unbiased decisions.
It’s often easy to say that we would never sell in that situation. But often, when your life savings are at stake, your previous certainty can fade. For that reason, it can be essential to have an accountability partner.
Consider that a study from The American Society of Training and Development found that a person is 65 times more likely to achieve their goal by having an accountability partner.
What would an accountability partner look like for your nest egg?
Often, it is your financial advisor. But, for those of you who may not work with an advisor, it could be a spouse, a friend, or a trusted person who knows that they might get a call from you during market downturns.
Apollo’s temple in Greece has the phrase “know thyself” carved into the entrance. Knowing yourself could be split into two main categories.
- Knowing your portfolio—how much stock, bonds, global exposure, etc. This will help you determine how relevant a benchmark like the S&P 500 is to your portfolio.
- If you are investing for the long-term, don’t deviate from your strategy because of your neighbor’s news or the S&P 500. Keep the end in mind.
Working with an advisor to understand the ins and outs of the S&P 500 is a smart way to improve your financial literacy and set you up for success in the long run. The fee-only financial advisors at TrueNorth Wealth offer asset management services to help our clients achieve financial freedom.
To learn more or schedule a no-cost consultation, contact us today!
