Our series continues with a myth that is best addressed by stating it as a question, “Should a well-managed investment portfolio be expected to beat the overall stock market?” The answer is both “yes” and “no.” It depends on what you are measuring and comparing.

 

 

Tracking the Indices: It is not unusual for individual investors to look to stock market indices, such as the Dow Jones Industrial Average (the Dow) or the Standard & Poor’s 500 index (the S&P 500), as a benchmark for returns. Even though the Dow is comprised of just thirty stocks, many investors evaluate the performance of their own portfolios with comparisons to the appreciation of the stocks in the Dow or the S&P500.

 

Return Comparisons: No, a well-managed portfolio should not be expected to beat the stock market’s returns. Simply comparing a portfolio’s performance to that of a stock index may provide a distorted view of the portfolio’s effectiveness. Let’s say, that your investment portfolio grew by a net 5% in 2014. The Dow was up 7.5% for the same period. Does this comparison mean your portfolio is underperforming? Not necessarily. Let’s also assume that in 2014 you had hired an investment adviser to manage your portfolio for a fee of 1.25%. The adviser built your portfolio with a variety of mutual funds with an average cost of .75%. This means the 5% growth of your portfolio was after paying a total of 2% in fees. Comparing a portfolio with such professional fees to an index like the Dow (which has no fees), is like comparing the cost of a steak at an upscale restaurant to that of a steak from the local butcher.

 

Risk Comparisons: Investment advisers often build portfolios with mutual funds or a large number of individual stocks. The point is to reduce the portfolio’s risk through diversification, while maintaining an opportunity for growth. A portfolio built with large, medium, and small stocks, foreign stocks, preferred stocks, and bonds, generally has less overall risk than investing in a stock market index.

 

Apples-to-Apples: A helpful way to assess a portfolio is to compare its components to similar investments. My firm uses research from Morningstar® (a leading provider of independent investment research in North America, Europe, Australia, and Asia) to periodically evaluate the risks and performance of our client portfolios. We also do this for prospective clients who want a second opinion. There’s no charge or obligation – unless, of course, you want me to cook you a steak!

 

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