Have you noticed that as soon as we ring in a new year, the commercials on TV change? Gone are the decadent advertisements urging us to splurge on food, jewelry and cars – replaced by ads for weight watchers, gym memberships and ways to monitor our credit scores. The beginning of a new year prompts most of us to take a hard look at the previous year and all too often we find more to regret than celebrate. We beat ourselves up over our failures and vow to do better in the future. This is as true for our trading results as for every other part of our lives. While, I believe that a frank evaluation of the previous year’s results can be a very beneficial endeavor, it only works if you compare your track record to a reasonable and responsible benchmark.
In a year where the S&P 500 rose over 11% after being up over 29% the previous year, many traders may worry that they are actually underperforming the market as a whole. First of all, if you seem to be underperforming the averages over the last couple of years, don’t beat yourself up too badly. You are in good company. According to the Wall Street Journal, “As of Dec. 19, more than 79% of U.S. stock funds had failed to beat their market benchmarks for the year.” The hedge fund picture is even more dismal. Hedge funds returned only about 1/3 of that for the S&P 500 in 2013. According to an article in Barron’s, most hedge funds expect returns in the low single digits for 2014. You may be wondering whether active trading makes sense in an environment where you can seemingly do better by simply buying and holding the SPY. The answer is that it all depends on what exactly you are trying to accomplish. Unless you are an active fund manager, your goal is almost certainly not simply to outperform an arbitrary bench mark. While that might give you bragging rights, it may not get you closer to achieving the results you actually need.
The behavior of the hedge fund market is instructive here. Contrary to what you might expect, hedge fund underperformance is not deterring inflows of new capital into hedge funds. Hedge fund investors are not simply seeking outperformance, but are generally looking for stability of returns with less volatility. Hedge funds, with their ability to go long or short the market, as well as use other hedging strategies, hold out the promise of that stability. Whether or not they fulfill that promise is a topic for another essay. I have a similar goal for my trading account. I seek a certain level of returns every year. If I meet or beat those returns, I count that as a success regardless of what the S&P does. If I aim for 10% and reach that goal, I have achieved my personal benchmark. It makes no difference to me if the S&P returns 30% that year. Why am I willing to accept lower returns in years when the market soars? Because I also expect to make that money when the market stagnates, or even falls. 10% returns year in and year out is far more valuable to me then soaring results one year and dismal results the next. I am also willing to accept lower returns because I structure my portfolio for lower risk. I keep a far greater portion of my trading account in cash, then I would be able to if my only goal were to beat the market. I take the risk that is appropriate for my personal goals. Those goals are dictated by my needs and never by the vicissitudes of the market.
If you want to make sure that you don’t underperform the market, then invest in the market. In fact, that is my strategy for most of my retirement funds. I invest in the SPY to take advantage of my expectation that over the very long term, the United States economy will flourish. If you have a different goal, a goal that is more tailored to your own needs, then celebrate when you achieve it and don’t worry about being average.