We are now in the seventh month of the year and year to date the S&P 500 is up a little over 5%. If you have a diversified portfolio that includes exposure to international stocks and bonds, your portfolio is either close to break-even or down for the year depending on your mix. You are probably wondering what is going on. First, bond prices have been under pressure due to rising interest rates. The most widely-used bond index, the U.S. Barclays Aggregate, is down around 1.50%. Second, most international stock markets are also down this year. If you think of a foreign country, most likely their stock market is down so far this year. Germany, the strongest economy in Europe, has seen their market decline over 2.30%. Japan is down over 2.80%, the Shanghai Composite is down over 14%, and Emerging Markets are down over 7%. At least the US market is strong, right? The overall market may not be as strong as you think. CNBC put up an extremely compelling chart yesterday (see below). In the S&P 500, 3 stocks (Amazon, Netflix, and Microsoft) account for 71% of the gains year to date! When you add in Apple the number goes to 83% and if you add in Alphabet (formerly Google) and Facebook, it goes to 98% of the gains!
Which benchmark should I use for my portfolio?
As you can see from the current market conditions, judging your portfolio by comparing it to a random index can be misleading. If you are currently beating the returns of the S&P 500, congratulations, but you are likely taking on too much risk (since 98% of the returns of the S&P 500 are coming from 6 stocks). If you consistently try to beat the S&P 500, human behavior, statistics, and history tell us you will most likely fail in the long run. This is mainly due to human emotions, too much concentration, and lack of discipline. In their Nobel Prize winning work, Harry Markowitz and Bill Sharpe showed that risk tolerance should be the primary driver of one’s portfolio mix. Your risk tolerance is what determines your portfolio, and your investment benchmark should always be your net worth and your ability to meet your goals.
How do I know my risk tolerance?
This is an extremely tough question. When I first started in the financial industry, we used to ask our clients, “As an investor, do you consider yourself conservative, moderate or aggressive”? If you have never invested before, could you really answer that question? Unfortunately, you don’t usually figure out your true tolerance for risk until you have experienced a loss. The financial industry has all kinds of generalizations based on age or how far away you are from retirement, etc. At Tempus, we not only get to know our clients, but we also use a tool called Riskalyze to help us assess individual risk tolerance. We drill down through a series of situational examples to more closely identify someone’s real feelings about risk. Based on your answers, you are assigned a risk number. We then create a customized portfolio to match or compare your risk number to your current portfolio to determine if changes to your investment mix may be needed. If you would like to know your risk number, click this link. It only takes a few minutes and you might learn something about yourself.
How do I determine my personal benchmark?
As stated earlier, the most appropriate benchmark is ultimately your ability to meet your goals. This starts with a plan. You know the old saying, “if you fail to plan then you plan to fail”. Your plan is similar to mapping out a long road trip. Where are we now? This starts with current net worth, cash flow analysis and preparation for all of the “what ifs” in life. Where do we want to stop along the way? These are our short and long term goals; sending the kids to college, vacations, a new car, etc. Where is the final destination? For most, we call this retirement or financial independence. Once your plan is crafted, it’s pretty easy to figure out how much you need to save and how much return is required to meet your goals. From here, we create the investment plan that takes on the least amount of risk required to achieve everything in your plan. This is now your benchmark.
If you have any questions or comments or would like to discuss any of this further, click on the contact tab at the top of the page and send us an email.