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Losing the Forest for the Trees: The Dangers of Comparative Investing

avoiding the traps of comparative investing

Some investors measure financial success by comparing their returns against popular benchmarks like the S&P 500 Index. It can be comforting to know how your investments compare to others … but there’s a catch.

If you aren’t comparing your investments to similar investments, the results can misinform rather than enlighten your decision-making. This will knock you off-course from the very success you’re seeking to achieve.

The financial industry has a term for this: tracking-error regret. To avoid succumbing to tracking-error regret, you must first recognize it.

 Don’t Fall into the Tracking-Error Regret Trap

It’s not uncommon to see popular headlines like these in the financial press:

“The S&P 500 is up 19% year to date!”

“International stocks offer double-digit returns in Q2!”

“Top variable annuities deliver 15%+ performance in 2012!”

If your own portfolio’s growth seems anemic in comparison, you may regret the decisions you’ve made and wonder if you should make some changes. This is when it’s important to recognize that tracking-error regret occurs when your carefully designed investment portfolio underperforms popular market benchmarks.

Before you switch gears, ask yourself: Are you using the right gauge for the measurement? The above figures may be accurately reported, but what do they really mean to you and your wealth?

How to Read Those Popular Headlines with No Regrets

It’s hard to read that the S&P 500 is up 19% year to date without feeling like your portfolio is underperforming. Financial success isn’t defined by how closely your returns happen to match a common benchmark. Instead, financial success is about you and yours.

On those terms, financial success happens in the following circumstances:

  1. You and your family have enough wealth to achieve or sustain your desired lifestyle according to your personal goals.
  2. You are able to focus the majority of your time and energy on doing the things you enjoy with the people you love, instead of worrying about financial headlines.

You can achieve this measure of success in several ways. The general rule of thumb is to concentrate on actions you can expect to control and avoid being entangled by those you cannot.

Investment Management Entangling Activities
Minimizing investment costs Hyperactive (expensive) trading
Forming a personalized investment plan Second-guessing your carefully laid plans
Building and maintaining a customized portfolio that reflects that plan Trading based on reactions to outside events
Measuring success according to whether you are on track to achieve your personal goals Assuming failure if your portfolio doesn’t always track a common benchmark

The Purpose You Should Build Your Portfolio Around

Your financial portfolio is not built to slavishly track a common index, so it should come as no major surprise when your portfolio and its components periodically deviate from their closest benchmarks. Your portfolio should instead be designed for – and measured against – a far greater purpose: you and your desired destinations.

To find out more about how to build an investment portfolio that works for you, read our eBook 9 Principles of Intelligent Investors.

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