Relative or Absolute Returns?

Download Full Report

This article was authored by: Lance Roberts

Relative performance is the comparison of your portfolio’s returns to those of some benchmark index. Absolute performance is the return of the portfolio itself on a year-over-year basis. Changing your view from “relative performance” to an “absolute” investment strategy can significantly increase your long-term results. This is because behavioral biases are controlled, leading to fewer emotionally driven investment decisions. Without clear goals, investors tend to take on excessive risk, as investment decisions become based on emotions rather than a strategy. The most significant contributor to long-term problems is comparing one’s portfolio to an all-equity index. This is hugely flawed, as there are many differences between an index and your portfolio. The index contains no cash. Indices have no life expectancy requirements, but you do. An Index does not have to compensate for distributions to meet living requirements. Indexes have no taxes, costs, or other expenses associated with them. An index can substitute at no penalty; you can’t. Clients who have learned the wisdom of “enough” are significantly happier. Their benchmark is not an artificial one, but one based on their own goals and risk tolerance. They are comfortable that the risk they accept is within the range they can emotionally withstand. With that understanding, investing becomes a process to obtain their goals with as little risk as possible. For those who are not satisfied with simply beating the average over any given period, consider this: if an investor can consistently achieve slightly better than average returns each year over a 10-15 year period, then cumulatively over the full period they are likely to do better than roughly 80% or more of their peers. They may never have discovered a fund that ranked #1 over a subsequent one or three-year period. That ‘failure,’ however, is more than offset by their having avoided options that dramatically underperformed. What’s more important – matching an index during a bull cycle, or protecting capital during a bear cycle? Avoiding short-term under-performance is the key to long-term out-performance