January 12, 2022 – Few personal finance topics get more attention than how to manage money. Interestingly, writers, speakers, and professional money managers educate those who pay little attention to the subject but have the money to manage. Based on recent financial literacy statistics, the goal of educating the American public on personal finance topics has not been very successful. And when you apply that deficiency to an economic area of great interest, their money, you can see the potential for a significant disconnect. Sprinkle in the complexity and jargon “teachers” use in their communication to get an investing public unprepared to take control of their finances.
This introduction provides the context for a broader discussion on setting expectations about the performance of your portfolio. Back to the question:
We believe that a “diversified portfolio” will provide a higher return over time than one that is not. Simply put, do not put all your eggs in one basket. Diversification addresses different types of investments, i.e., stocks, bonds, gold, real estate, and currencies, and it means different sizes of companies: i.e., big, medium, small and micro. It considers various types of ownership, some being held by the public and traded on known exchanges and those owned privately by investors. Finally, your investments are part of a global marketplace with companies where your investments are located and/or operated around the world. These companies can be in the United States, in foreign countries with a developed economy, or foreign countries with an emerging economy.
When considering the question of underperformance to “the market,” how is the market defined? The financial press will typically quote the S&P 500, the Dow, or the NASDAQ. Commonly used as a proxy for “the market,” these benchmarks represent a subset of prominent, publicly traded companies operating in the US. With an understanding of the principles of diversification, comparing your portfolio results to any one of these narrowly defined indices would be like inquiring, “why hasn’t my house appreciated like a mansion in Dubai or a tiny house in Beverly Hills or even the condo located in the next town?”
Why do people ask so few questions about real estate valuation? How come they can manage their expectations compared to the market? Because the real estate industry has done a phenomenal job in educating clients about the drivers of value in real estate. Almost every homeowner knows the adage “Location, Location, Location”! They know what impact size (lot & land) means. They know what parts of their town, state, country, and even some foreign locations are desirable and command a higher value. They know the benefits of a sound school system, easy access to healthcare, convenient commutes, and the burden of high property taxes.
Taking a cue from real estate, I would suggest the appropriate question to ask about your portfolio would be, “How have my investments performed in the markets in which they operate?” Or consider even a better question, “Are my investments appropriate given my goals and objectives, and if so, are they performing as we should expect?”