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Market Strategies - Benchmarks

A young portfolio manager asked an Eighty-year old advisor for his secret to successful investing.

Old advisor: "Good judgment."

Rookie: "How do you get good judgment?"

Old advisor: "Experience."

Rookie: "How do you gain experience?"

Old advisor: "Bad judgment."

One of the first things most investors are "conditioned" to focus on when they start investing, is to compare your results against an Index or some sort of benchmark. It is ingrained into our thought process so much that it almost becomes second nature. It's almost as automatic as breathing.

Wall Street has conditioned our thinking into this little box that says if you can't beat the Index, you might as well own it.

I believe that comparing your results to a benchmark is not only defeating, I think it qualifies under the bad judgment response by the Old advisor above.

The purpose of this instablog is to deliver the message that if you make the decision to take control of your investments, and you are wanting to compare your results against an Index, that it is "Crazy Thinking!"

Wall Street loves the concept of us using a benchmark because they know we won't beat it every year. People who manage money for a living can't beat the market every year, so they know we can't either. Money managers want us to doubt ourselves and our abilities. They want us to change our strategy and buy the Index. They need us to doubt ourselves and buy the Index. That's how they earn their fees. They want us to let them manage our money so they can't outperform the Index every year either, but at least get paid for that underperformance.

This instablog is not about owning or not owning an Index if that's your choice. It's about not comparing your results from other investments to it.

I thought most people become self directed investors because they were dissatisfied with the performance of an Index and wanted to better themselves. If that's the case, then why compare your results to something you don't want?

I know some of you will continue the exercise. Some of it is insecurity. Some of it is reassurance. Some of it is ego gratification. Regardless of the reasons, I think it is "Crazy Thinking."

Let's start with this. Do you know what the S&P 500 value is going to be at the end 2013? Do you know whether it will finish up or down? Do you know what the percentage of increase or decrease it will be? Then if you don't know the answer, how can you beat something you have no idea of what the result is going to be? How do you plan for it? How do you execute?

One of the most important aspects of succeeding in anything we do in life is to have specific, meaningful goals. We need a target to shoot for. How do you hit a target you can't see? How do hit a target that you don't even know is the target? You don't know what the Index target is. I'm starting to think that those who chase the Index are like the blind leading the blind. Nobody knows where they are going until they get there, but they don't know where there is. ... Ha!

One of the portfolio's I manage is called Project $3 Million. The portfolio is posted online for others to follow. It's a real portfolio, using real money, and it's updated in real time.

Here's the link: ...

This portfolio's goals were established at the end of 2008. The pre-determined goal for the portfolio value at the end of year 2012 was $74,355.49. That is where the portfolio needed to be to stay on schedule for the $3 Million at age 65. The 2012 year end result was $84,710.60. The portfolio is ahead of schedule.

Those goals are specific! We know exactly what the target is. The target for year end 2013 is $86,959.44 (already achieved). The target for year end 2014 is $100,643.33 (now an accelerated target since 2013 is already acquired). We know the target for every year over the next 40 years and we know this now. Since we know the target for every year going forward, we know how to plan for it, we know how to adjust as we go, we know how to accelerate as we go.

Anyone want to take a shot at telling me how to plan like this using an Index? ... Anyone? ... Anyone? ... If not, why should I even care what the Index is doing?

Comparing your results to an Index, 12 months after the fact, since you couldn't plan ahead because you didn't know what the end result was going to be, is akin to throwing stuff up against the wall and hoping most of it sticks.

Some of you will still insist on making the comparisons though. So my question is this. If you don't beat the Index, what are you going to do? ... Nothing? Then what's the point? ... Are you going to switch strategies? If so, are you going to invest all of your money into the Index? ... If not, what's the point?

As stated above, I think it comes down to insecurity, or reassurance, or ego gratification. Otherwise, I don't get the point.

The danger of making comparisons!

In a recent article written by Bob Wells, someone commented on my strategy vs the S&P 500 Index. That person looked at Project $3 Million and determined that it only produced a 7% return in 2012. I don't know what the S&P did in 2012. I think it was around 12%, maybe more, I don't keep up with it. I know the portfolio was up 20.6% year over year, but some of that was helped by cash contributions. That person told me I would have been better off in SPY.

Well, garbage analysis in, garbage analysis out!

The person discounted the objectives of the portfolio. Didn't know how or when the cash distributions were made, and didn't understand that we were averaging up our positions in a strong market environment.

He came to an erroneous conclusion, one that would have had him, and me, if I listened to him, switching strategies, a strategy that is so successful, it's exceeding the pre-determined goals.

When you look at the performance of the Index at year end, it's very simple, it ended last year at one point, it ended the next year at another point.

My portfolio doesn't work that way, yours probably doesn't either. Cash is coming in or going out, changes are being made, most people don't know how, or wish to make the effort, to determine an accurate comparison between an active account vs a passive account.

Project $3 Million has cash deposited in the account twice a month. Most of those funds don't have an entire year to perform as the Index does. Am I supposed to think the funds being deposited later in the year are going to keep up with the market in a year where the market is doing well and had all year to perform? ... "Crazy Thinking!"

The cash being deposited is being added to existing positions. We are averaging up. All dividends are reinvested. Most dividends don't have all year to perform and those dividends are also helping the existing positions to average up in price. When you average up, your profit percentage comes down. And I'm supposed to think that's an apples-to-apples comparison to the Index?

How am I supposed to outperform the market "every" year when I'm averaging up? The goal isn't to beat the market every year. The goal is to focus on the objectives we have established and the strategies to carry it out. In the long run, the market won't keep up with us.

The person who told me I would have been better off in SPY didn't understand another concept. Suppose I did have 100% of the portfolio in SPY on January 1. Cash was being deposited into the account twice per month, every month, and that cash was put to work by building positions. We would have been building SPY. We would have been averaging up! Since we were adding cash, and averaging up, we wouldn't have matched the market even though we were the market. Think about it! ... Yet people will still want to make those comparisons. ... "Crazy Thinking!"

What about re-balancing? Re-balancing overweight positions is thought to be a prudent portfolio management tactic. If you choose your selections carefully and they enjoyed the success you envisioned, you may have to sell part of that successful position as a risk management technique. Where does the cash from the sale go? The cash from an overvalued position usually goes into an undervalued position. Outperformance to underperformance with the hope that the company is temporarily underperforming and the market will eventually realize the true value and make that position successful. It just takes time.

Well, if we are selling something that is outperforming the market, and buying something that is temporarily underperforming the market, how do I outperform the market every year? ... Then what's the point of comparing your results to the market?

Do we really expect we are going to buy companies with a temporary beaten down share price and the market is going to immediately reverse course on the day we buy and head higher? It takes time. How can we expect to beat the market every year when we are buying underperformance?

The person telling me I would have been better off owning SPY didn't take the portfolio objectives and Mission Statement into account.

Primary Objective:

Income replacement! ... The objective is to start earning an income stream now to replace the income that will be earned throughout the working years. The goal is to achieve $10,000 per month income in retirement. The income stream will need to continue to grow to stay ahead of inflation. A portfolio of $3 Million with a yield of 4% will accomplish that objective. Hence the title of this portfolio ... Project $3 Million.

Mission Statement:

To earn an income stream that is reliable, predictable and increasing.

The Portfolio Value Goals vs Results:

2010 - $52,053.79 ... $54,949.47 ... up 23.2%

2011 - $62,746.55 ... $70.221.20 ... up 27.8%

2012 - $74,355.59 ... $84,710.50 ... up 20.6%

The portfolio is ahead of schedule. Why would I worry about what the market is doing? Shouldn't I be focused on my goals? The strategy is working.

In my opinion, by comparing your results to the market or an Index undermines what it is you are trying to do. Why would you want to undermine something that is more successful than you planned for?

This series of instablogs on Market Strategies has been about trying to get people to understand that stock selection performance should not be the focus, your strategy should be. Then you own the stocks that support your strategy. If your strategy is sound, and I know mine is, you'll beat the market in the long run. I know that!

The Mission Statement talked about a reliable, predictable and increasing income. Here are the total dividend results:

2009 - $684.38

2010 - $1,693.33

2011 - $2,404.02

2012 - $2,808.46

That too is working!

The end objective for Project $3 Million is to have $3 Million yielding 4% which should generate $10,000 per month in income. It's that monthly income that is the objective.

Project $3 Million has a current yield of 4.0%. If I switched to SPY as was suggested, SPY only yields 2.07%. Project $3 Million would have to become Project $6 Million to generate the same income. ... Now tell me why is an Index a better option?

I'm beginning to think "Crazy Thinking" is turning into "Insane Thinking."

Again, this instablog isn't against "owning" an Index. Some people have no choice, others choose to. I have no problem with that. Project $3 Million has a small part of the portfolio in Index Funds.

This instablog is about not "comparing" your results to an Index once you commit to owning individual companies. Once you make the commitment, I think you should burn that bridge and make what you are trying to accomplish, work.

I think it is more beneficial to establish meaningful goals and focus on achieving them. I think one should find a way to compete and compare against themselves, always trying to improve, without something undermining what it is we're trying to accomplish.

We strive to set new monthly and weekly income goals. We keep track of our dividend records. That's a lot of fun!

Learn to compete against yourself.

Benchmarking is the essence of getting you to undermine your confidence and abilities. It attacks your sub conscious creating doubt when you don't beat the benchmark, and creating false motivation when you do. The benchmark will take body shots at you, trying to wear you down. The Market wants those fees. They need you to lose faith in your strategy and let them handle your business. Stop making those bad judgment calls and stop benchmarking.

When we stop worrying or caring what the market or others are doing, what I refer to as a bad judgment call, and we start focusing on our goals, we'll graduate from the rookie portfolio manager at the top of this blog and become that successful portfolio manager. It's all up to you.