How to avoid the danger of relying on “annual returns” to evaluate your portfolio
Like other sports fans, I am drawn to how a player is doing during the current season. After all, sports is very much about being in the moment, and in this season. The old Brooklyn Dodgers cry of “wait ’til next year” is not as relevant to today’s consumer. Just ask those of us here in South Florida who now find ourselves in the middle of two massive rebuilds (baseball’s Miami Marlins and football’s Miami Dolphins). Wait ’til 2022?
With investing, there is one big difference. There are no long “off seasons” where the game stops. Investing is a continuous process. Also, if done with care, it is hopefully a disciplined and repeatable process. Therefore, simply evaluating how you do during time periods dictated by the sun and the moon (i.e. the calendar) may make for good “sport.” But calendar years are only one of many ways you should look at how you are doing.
2019: the most deceptive year in stock market history?
As we near the end of the 3rd quarter of 2019, it is shaping up to be one of the most deceptive calendar years in market history. This is why the calendar year evaluation habit is important to talk about right now. Here are some quick pictures to show you why, using the S&P 500 as the “market.”
To start, the S&P 500 is up about 21% this year. That is a great return for less than 9 months of investment. But wait, there’s more…
…while many investors may have missed it, or simply forgotten, the end of 2018 was pretty sloppy. The S&P 500 fell over 15% in 3 weeks. It happened in December, which itself is uncommon. But it happened, and it is a big part of what creates the deception. After all, if you simply add the last 4 weeks of 2018 to 2019’s return, you get this: a still-solid return of around 9%. But a far cry from 21% since the start of this year.
Now, let’s go back just a bit further, to October 3 of 2018. That’s just about a year ago. The return of the S&P 500 over the past 49 weeks is about 4.2%. That is still not terrible.
The deception is the thing
None of this is about the particular returns of any time period. It is about how we honestly evaluate those returns. I have had a noticeable number of investors tell me that “the market is doing so great.” If you look over the past few years, and focus only on the S&P 500 Index, that holds water, so to speak. But if you look at how parts of the market are progressively breaking down, and that the S&P 500 has not advanced much since early 2018 (about 19 months ago), the perception changes. In fact, the S&P 500 was down for the full-year 2018. How soon we forget.
Think of it this way: if you had invested with a financial advisor last October, and all of that money was invested in an S&P 500 Index (which of course, you would not have to pay an advisor to do for you!), you would be up about 4% as you near your 1-year anniversary. Would you be upset, given how “great” the “market” has been doing?
This is the emotional side of investing. There are 2 groups of people that are at greatest risk of being caught up in the deception of annual rates of return.
- Those nearing retirement and are in “catch up mode” regarding their portfolios. They want to retire, but believe they are not financially able to. So they have FOMO (fear of missing out) and chase what could be the tail end of a 10-year bull market. They would be better off identifying ways to invest toward their goals, but using the stock market as a tool in that process. In other words, not relying on the market to bail them out, but using stocks as part of the plan.
- Young investors. They are in a position to learn now how things like year-to-date return obsession can throw them off course. They are at the stage of their investment lives where the more they learn “on the job” of being investors now, the better off they will be in the bear and bull markets of the future.
Past performance that matters
Hopefully, you have the key concept of performance deception down now. Finally, here is some “extra credit” for you. As a market historian, there are 2 calendar years that come to mind that remind me of 2019. One was the year 2000. Here is a chart of late 1999, where we saw the S&P 500 dip. Then, in late 1999, it surged, and did not stop until March of 2000.
At that point, a period of gyrating prices led to 3 straight down calendar years, and a total decline of nearly 50% from the early 2000 peak shown here. The chart below shows how this all set up, and what happened over the following 12 months…note, I did not say “year” because it did not happen neatly over a calendar year!
I could show you the other year. But I won’t (though if you reach out and request the charts, I will send them to you). The other year was 1987. That year, the S&P 500 fell over 20%…in a single day. Yet the full year ended up positive.
If you had a very hypothetical choice between the calendar-year return of 1987, the “crash year” and 2018, many people would probably choose 2018. Except that 1987 was a positive year for the S&P 500, and 2018 was negative. You see, past performance deception works in both directions! Don’t get deceived, get informed. It is much better for your financial health.
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