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Tale of the Tape

John Lim, 1:22 am ET

MY PORTFOLIO GAINED some 4% in 2021. While I certainly didn’t expect to match the S&P 500’s impressive 28.6% performance, I was surprised at how low my return actually was. This surprise is a lesson unto itself: We often overestimate our own performance.

There’s a number of reasons for my portfolio’s middling returns. First, I began 2021 with my stock allocation at around 40%. Bonds, cash, and gold and gold mining companies rounded out the rest of my portfolio. These other asset classes had poor returns last year, including -1.9% for bonds to -4.2% for gold.

On top of that, I have an unusually low allocation to U.S. stocks, which had a banner year in 2021. My stock allocation tilts strongly international, with an outsized allocation to emerging markets stocks. Emerging markets woefully underperformed last year, as this chart illustrates.

In fact, had it not been for the two individual stocks I own, my portfolio’s performance would have been even worse. Wells Fargo (symbol: WFC) and TotalEnergies (TTE) had a great 2021.

Still, there are five reasons I don’t fret about underperforming the S&P 500 in 2021 and why you shouldn’t, either:

1. The S&P 500 is not my benchmark (not even close). Unless you’re 100% invested in U.S. large-cap stocks, the S&P 500 is, at best, an arbitrary benchmark and, at worst, irrelevant. If you feel compelled to measure your relative performance—certainly not an imperative, as I discuss below—what’s a more relevant benchmark?

I used my end-of-year asset allocation to create a blended benchmark, using exchange-traded funds to measure asset class performance for 2021. The results are summarized below:

The 2021 return of this portfolio was 6.1%, two percentage points higher than my 4% gain. As my asset allocation varied over the course of 2021—with progressively more in stocks—the benchmark I created is imperfect. Nonetheless, it’s a reasonable starting point. The verdict: My portfolio clearly underperformed its benchmark in 2021.

2. Last year enabled me to invest more at lower prices. I added significantly to my stock allocation in 2021, particularly emerging markets. As those stocks fell in price, I happily bought more. This is the one corner of the global stock market that’s truly cheap, with a cyclically adjusted price-earnings (CAPE) ratio that’s less than half that of the U.S. But as 2021 clearly demonstrates, a low CAPE ratio shouldn’t be the basis for a market-timing strategy, at least in the short term. Which brings me to my next point….

3. The short run makes headlines, but it’s the long run that matters. In this frenetic age of instantaneous market quotes, it’s easy to forget that one-year performance still constitutes the short run. If you’re a decade or more from retirement, as I am, annual returns are largely meaningless. What really matters is your compounded returns over multiple decades.

While I have no idea what’s in store for markets in 2022 or 2023, I’m confident that my portfolio will perform well over the long run, by which I mean a decade or longer. Paradoxically, investment returns over the long run are far easier to predict, yet nearly everyone is obsessed with the short run. A decade from now, you’ll more than likely be reading articles like this one.

4. Investing is neither a competition nor a beauty contest. We live in a hypercompetitive, comparison-obsessed age. This mentality is further inflamed by social media. But personal finance and investing are not competitive sports. My financial goals are different from yours, and yours are different from your neighbor’s.

A friend of mine has just 10% of his portfolio in stocks. In financial parlance, he has a very high degree of loss aversion—he really dislikes losing money. But that’s the right asset allocation for him.

As I’ve aged, my risk tolerance has also fallen. The idea of holding a 100% stock portfolio—which I did for many years—would today make my stomach churn. Having about two-thirds of my money in stocks feels about right. As a result, when it comes to investment returns, I’ll never “knock it out of the park.” On the other hand, I’m confident that my portfolio will enable me to reach my financial goals without losing sleep.

5. The calendar year is an arbitrary point of reference. Market returns are lumpy. Case in point: If you measure my portfolio’s return from Jan. 14, 2021 to Jan. 14, 2022, it comes in around 8.5%. Yes, the first 10 trading days of 2022 have been very good for my portfolio.

I don’t give much credence to short-term performance, let alone to two weeks of outsized gains. My point is that markets are unpredictable in the short run—and that investors pay far too much attention to annual returns.

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mike schellenberger
mike schellenberger
4 months ago

Can someone tell me the formula used to come up with the total return of 6.1% for the asset allocation listed in the table above?

John Redfield
John Redfield
4 months ago

Use the allocations as decimal weights and multiply the associated return, then sum.

Jack McHugh
Jack McHugh
4 months ago

Yikes! I’m so glad some years back I adopted Sgt. Schultz as my investment advisor (“I know nothing”), and a (very) streamlined version of Paul Merriman’s “Ultimate Index Fund Portfolio” as my model. My only decisions and moves in the last couple pre-retirement years have been to dial-back the equities just a smidge to 45%.

BTW, if you are using Emerging Fund index funds, check out their China allocation. In early 2021 I noticed Vanguard’s (and the other Bigs) was 50% PRC, which I did not like at all for a lot of reasons. So I bailed into XCEM, which has been interesting and modestly profitable vs. the VG EM.

Last edited 4 months ago by Jack McHugh
Nick M
Nick M
4 months ago

With 7% inflation and -4% returns from gold, I would recommend reconsidering why you are holding any gold at all. Gold has been an inflation hedge in the long run, but my understanding is that the long run for gold is likely 100 years, and we don’t get to experience more than one of those. Pension funds and endowments expect to survive multiple 100 years periods so they hold gold, but it’s typically inappropriate for individuals.

My two cents: Shifting from gold to a broad US large cap value index would give you something closer to equal weighting in US, Developed, and Emerging. Using a value index should address concerns about buying at high US valuations, and equal weighting can shorten the duration (though not the depth) of portfolio drawdowns.

Also, if not being done already, keeping the cash outside of investment accounts tends to allow for better returns (via CDs, I-Bonds, etc) and makes it accessible for life emergencies. It also reduces the temptation of market timing.

Otherwise, I think you have a good portfolio and good perspective when it comes to not comparing portfolio returns to the returns of a given stock market.

Last edited 4 months ago by Nick M
Jack McHugh
Jack McHugh
4 months ago
Reply to  Nick M

I added a wee sliver of ETF gold to my portfolio a year ago as a hedge against “crazy,” not inflation. I remind myself of that as gold sits like a bump on a log while inflation soars.
Geo-politics is another rationale, but one I trust less than “crazy.”

Last edited 4 months ago by Jack McHugh
ishabaka
ishabaka
4 months ago

An example of how stock pickers/market times fare worse than people who buy and hold a diversified portfolio of index funds. If you factor in whatever you believe inflation to be, he lost 3 – 5% in a year the market boomed.

parkslope
parkslope
4 months ago

The fact that all benchmarks have an arbitrary component doesn’t change the fact that they are useful for judging the performance of one’s investments. Of course, as you point out, one year is a short time period in the investment world. The only reason why the S&P is of little importance for your portfolio is that you only have 11% in US stocks, not because of any arbitrary characteristics it may have.

Your current portfolio reflects your strong belief that stocks in the S&P are overpriced and that international stocks are undervalued. While your shift to your current allocations is a form of market timing, it will be much less so if you are committed to not changing your allocations until there is a significant change in the data on which they are based.

steveark
steveark
4 months ago

My portfolio has more exposure to large cap US than yours so it did better but it also has a healthy amount of underperforming bonds and non-US stocks. And some alternatives and gold related. I obviously did not match the S&P either, but like you I did not intend to. That’s a roller coaster of an index and so very concentrated. I’ve been retired 6 years and hope to be retired for another thirty. I don’t want to be in lock step with an overvalued, geographically fixed entity when the world is a much bigger place than just the US. It does sting a little when the market seems to outdo your portfolio, but it stings a lot less when the index gets cut in half and your portfolio still holds most of its value!

Sean Mooney
Sean Mooney
4 months ago

I have been in emerging market for a while , buy and hold ETF. My concern is that you need a stabile country, a democracy would be wonderful LOL, and some real rules and regulations in those markets. Otherwise, I fear meaningful returns due to corruption, cronyism, etc. will be a pipe dream. Maybe in and out is a better strategy?

johntlim
johntlim
4 months ago
Reply to  Sean Mooney

I think trying to time the market is a fool’s errand. Also, remember that all the concerns you mention are typically priced into the market. They raise the risk premium which is equal to the expected future return.

Brent Wilson
Brent Wilson
4 months ago

You started the year at a 40% Stock allocation, and ended the year with a 67% stock allocation? I understand a little bit of drift during volatile timeframes, perhaps as a result of loading up on stocks when they are cheap and seeing these stocks increase further after a rebound.

But going from 40 to 67 is a fairly large jump. Have you considered sticking to a more stable asset allocation?

johntlim
johntlim
4 months ago
Reply to  Brent Wilson

You make a valid point. I am striving to have a more stable asset allocation in the future. More generally, I hope to do as little tinkering as possible with my portfolio going forward. Thanks for the comment!

John Wood
John Wood
4 months ago
Reply to  johntlim

To offer a differing view, the philosophy of Warren Buffett and Charlie Munger resonates more with me. They invest heavy in their best ideas, worry not about multi-market diversification, and let their winners run.

Ormode
Ormode
4 months ago

My conservative portfolio of US dividend paying stocks was up 13.7%. But more importantly, my dividend income continued to appear every quarter, and I had money available to spend if and when I needed it. Most of my stocks increased the dividend during the year.

BMORE
BMORE
4 months ago

Thanks for sharing your investment experience. Your allocations are similar to last year’s expert projections of foreign markets being underpriced and positioning for a correction with gold; meanwhile Mr/Ms Market did his/her own thing. David Swensen recommended a balanced diversification in his investment guide (densely written, but brilliant) that included real estate and Tips, which did well last year. He includes emerging markets, but said they are a yo-yo. I usually spice things up with a total of 5% lean into hammered out areas—mid 2020 it was Energy index funds and small cap value index funds that were down 50% and regained that.

Last edited 4 months ago by BMORE

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