I have been relatively quiet on posts lately, due to a spurt of busy-ness that kept me away from the office and the opportunity to gather thoughts for blog posts. While watching the market bump and sway in recent weeks, I have given some thought to how investing clients experience volatility, as well as how clients think about short term vs long term returns.
The chart above shows the last month of data (September 5 to present) for 4 different stock market index tracking ETFs (exchange traded funds). For variety, I chose the SPY (S&P 500 index), IWM (Russell 2000 "small cap" index), the VT (Vanguard total world) and VTI (Vanguard total US stock).
Something that jumped out at me (apart from all of the sampled funds being "down" over the period) was the disconnect between the S&P fund and the others. The S&P 500 is not a "strategy" based fund, but rather a (mostly) passive vehicle for tracking the performance of 500 large companies. Therefore, the disconnect in returns over the past month must have to do with the sample of stocks held among those 500 versus the broader selection in some of the other funds. Or perhaps the relative size of the holdings -- as mentioned on this blog before, one stock in particular (Apple - AAPL) represents a significant portion of the S&P 500 (around 3.4% as of this writing). Apple had a decent month, while many other stocks fell -- maybe that is part of the disconnect in the S&P 500 and the other indexes tracked here.
Another part of my thinking over this month of moderate declines is around how my clients and the rest of the investing public think about returns. When we say to ourselves "the market is up/down/unchanged on the day/month/year", which market do we mean? And when we compare our own personal performance to "the market", are we making reasonable comparisons?
The basic idea behind comparing a given account or group of accounts to "the market" is called benchmarking. And at its core, benchmarking is relatively simple. If a given client (or account) elects to assign a risk tolerance and investment objective that seems pretty to similar to those exhibited by the S&P 500, then it may be reasonable to periodically compare the account's performance to that of the index. Or, if the account opts in to a risk tolerance and investment objective more consistent with a blend (say 80% S&P 500 and 20% 10 year bond rates), then a blended benchmark may be appropriate.
However, in my experience benchmarking does not stay basic or simple for long. In the real world, clients needs for liquidity (taking cash out of an account) tend to complicate comparisons to the benchmark; similarly, clients with personal situations that evolve over time will require coincident evolutions of benchmark.
The complications do not remove the value and need of benchmarking returns, but they do necessarily require a sophisticated and flexible approach to applying those measures.
David R Wattenbarger, president of DRW Financial
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