The S & P 500 Index is Not a Portfolio

Mar 2014

I read an interesting article the other day that was written by one of my peers in the industry, Craig L. Israelsen. Mr. Israelsen was making the point that it is a real challenge for individual investors to stay away from comparing their portfolios to one particular market index like the Standard & Poor’s 500 Index especially after a strong year like 2013 when the S & P 500 Index finished up nearly 33%.

Individual investors have a bad habit of feeling as though their portfolio is inadequate in years when the market rallies substantially, but this may be faulty thinking and too short-sighted. Mr. Israelsen interestingly points out that the S & P 500 outperformed a multi-asset portfolio 55% of the time, during 24 out of the 44 years between 1970 and 2013. (Footnote: the multi-asset portfolio is allocated among seven asset classes: large and small U.S. stocks, non-U.S. stocks, commodities, real estate (REITs), bonds, and cash.) Over that 44 year period, there were some years when the S & P 500 outperformed the multi-asset portfolio by very wide margins, including 2013, but what’s interesting is that the two ended up with a 44 year performance that was nearly identical. The S & P 500 had a 44 year average return of 10.4% verse 10.3% for the multi-asset portfolio.

The initial reaction from most people is one of surprise. How could an all-stock index like the S & P 500 achieve the same performance as a diversified portfolio? The answer clearly lies in the down years. There were more down years for the S & P 500 versus the more diversified portfolio, and some years were significantly worse. In fact, the average negative return for the S & P 500 was 15.2% versus 8.7% for the diversified portfolio over that 44 year period. That is a substantial difference, and the reason why it makes no sense to compare one’s diversified portfolio to that of the S & P 500 Index. We obviously do not know what the next 44 year period will bring, but the previous period included economic expansions and recessions, high inflation, low inflation, low gold prices, high gold prices, and a variety of geopolitical events on a scale not seen since the great depression periods of the 1930’s so it was a meaningful period of comparison.

The fact is anybody that had a diversified portfolio last year underperformed the broad stock market indices by a wide margin. This was no surprise to our firm. The only way one could have kept pace with the market would have been to have had zero bond exposure, and to have had their money entirely invested in large U.S. stocks. This is an extremely risky strategy because of those unexpected negative years that most investors have difficulty experiencing for any length of time.

And therein lies the bigger point of this blog: if your diversified portfolio is providing solid returns and is helping you reach your financial goal, don’t waste time and energy fretting over whether it is keeping up with your favorite market index. Instead, spend your time making sure your portfolio will continue to meet your needs through regular rebalancing and adjustments as needed. That will go a long way towards ensuring it will continue to help you reach your goals, and may even eliminate your need to take blood pressure medicine!

Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Investing involves risk and investors may incur a profit or a loss. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making an investment. Please consult with your financial advisor about your individual situation.

Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.

More News