By Mickey Welcher
As an investment advisor, I get asked many questions about the market, but there is one that I get more than others: “Why is my portfolio not doing as well as the S&P 500?” The answer is not as easy as people would expect.
If you turn on CNBC, CNN or any news show, all you hear is how we are hitting all-time highs and how much the market is up for the year. Yes, that is all true. But when it comes to investing, there is so much more to understand. Good portfolios are much more diversified and are not as simple as one index.
The S&P 500, for example, is comprised of only 500 stocks that are weighted based on average market capitalization. No prudent investor would ever have a portfolio that holds only stocks, as this would cause excessive volatility in their account. When the market is going up, everything’s great, but significant value fluctuations would occur during volatile or bear markets.
When a client opens an account with my firm, they are asked questions based on their risk tolerance and their financial goals. Their answers help us build a portfolio that will allow them to feel comfortable during volatile and weak market periods. Everyone feels good when the market is going higher. When the market drops is when you want the client to feel comfortable with his portfolio and not make panicked decisions.
An example of this diversification would be an investor who has a moderate risk tolerance. Let’s say this client has a balance of 50 percent stocks and 50 percent bonds in his portfolio. And let’s assume the stock market was up 20 percent for the year and bonds were up 2 percent for the same period. This client would realize an overall 11 percent gain for the year. We figure this by multiplying the two rates of return by their allocation and adding those numbers together: 20% x 50% + 2% x 50% = 11% overall.
You can see how this client underperformed the S&P, yet maintains the perfect portfolio for his risk tolerance. The bonds in this portfolio will help if the market has a down year because they will not fall as much as the stock market.
Next time you are wondering why your portfolio is not doing as well as the S&P 500 or Dow Jones 30, remember this article. Diversifying your portfolio is far more important than beating indices.
Mickey Welcher is founder of Envestim, a low-cost financial advisory firm for anyone looking to start or manage their portfolio. He can be reached at mickey@envestim.com.
