When browsing portfolio options, investors rarely study them in isolation. Whether it’s the S&P500, a second lazy portfolio, or their own current asset allocation, it’s natural to compare a prospective portfolio to a relevant benchmark. In fact, one of the primary goals of Portfolio Charts is to collect as much information as possible about various strategies in one place to aid in the learning process.
Each of the charts and tools here can be used to study differences in portfolios, but it feels like there’s room for one to do that more directly. I’ve been experimenting with a few ideas, and have come up with something that I think approaches the problem from a new angle without overlapping the other calculators too much. I call it the Benchmark calculator. As a nod to human nature and a reminder to those who use it, you can also think of it as an Envy chart.
The Benchmark calculator allows you to visualize two different portfolios side by side and shows not only how the two portfolios grew over time, but also how they stacked up each individual year along the way.
The top chart plots the compound real returns for both portfolios so that you can directly compare total inflation-adjusted returns. It’s most helpful for studying relative account values over time and to watch portfolios rise and fall with markets. The default start year is 1972 (the earliest possible for the data set), but one can vary the start date to see how the portfolios would have grown based on different start dates as well. One can always cherry-pick a start date that makes one portfolio shine over another, but move the start dates around to less advantageous times and you’ll start to see the big picture. Remember you do not have the benefit of cherry-picking your own start date, so be careful about bypassing years that make one portfolio look bad. Learning how portfolios responded to certain economic conditions is very educational. Assuming that the times that made a portfolio look bad can be safely ignored and bypassed is probably a bad idea.
The chart is logarithmic, which means that each line is a multiple of the original value. For non-math-geeks, logarithmic charts give a more accurate representation of how the portfolio performed at each point along the way, as the peaks and valleys scale as a percentage of the portfolio instead of simple dollars. If you’d like more info, Motley Fool has a pretty good explanation in not-too-complicated terms.
The bottom chart takes the comparison one step further and shows the relative performance of each portfolio during every individual year. The number you see is the real return of Asset Allocation A minus the real return of Asset Allocation B. So a positive number means that that A had a higher return that year, while a negative number means B had the higher return. Along with the “Favorable Years” count and “Biggest Advantage” for each portfolio, this data will help you see beyond the total returns to understand how it would have felt to watch the two portfolios as they grew over time. Based on investing psychology, this is where it gets really interesting.
As you will only ever see your personal portfolio year by year without the benefit of knowing its ultimate value in the future, this is where envy often kicks in. Note that while the example portfolios above ended with similar account balances in the long run, the individual years swung back and forth regularly along the way by up to 20% in either direction. An investor following both portfolios with a persistent desire for better returns would suffer great envy no matter which portfolio he chose. If he switched every time his own under-performed, by buying high and selling low he inevitably would have lost to both options.
One of the interesting things about playing with the Benchmark calculator is the moment you realize just how often your portfolio under-performs something else. For example, did you know that the total stock market lost to a simple treasury money market account 12 different years since 1972? Or to gold almost half the time? I’m certainly not saying that either are better long-term investments, but that’s exactly the point. By comparing our own investments to arbitrary benchmarks on short-term timeframes, we open ourselves up to emotions and thought processes that are detrimental to our long-term investing health.
The Benchmark calculator is intended not to help you act on those impulses, but to show how different portfolios can achieve similar long-term results via very different paths. An important and often overlooked step in passive investing strategies is to recognize that a perfectly good portfolio will sometimes trail another good one even for several years in a row and that’s ok. You don’t need to have the best returns every year to achieve your ultimate financial goals. In fact, having a strategy that does not require you to always stay a step ahead of the markets to win in the long run is precisely your advantage both financially and emotionally.
While one should be careful not to submit to envy, there are certainly benefits to displaying two portfolios against each other. I especially enjoy this tool for its ability to plot the relative volatility of two portfolios. For example, the sample above really shows off the smooth returns of the Permanent Portfolio with virtual straight-line growth no matter what year you start in. Even when other portfolios may beat it handily with more advantageous start years, you can count on the Permanent Portfolio to steadily perform and weather economic conditions that eventually bring the others back to earth. Other portfolios here are similarly consistent, and that’s a great goal for anyone looking for an enduring investing option.
Give the Benchmark calculator a try, and hopefully it will help you understand your investments in even more detail. Use it to compare different portfolio options. Or maybe just use it to compare against something other than the S&P500 benchmark that you’ll find on so many other sites. For those looking to invest for the first time, try simply setting a portfolio to all zeros and compare different options to doing nothing!
Sometimes looking at a few different options is just the motivation you need to make a good decision.