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.
