The Keys to Understanding Investment Performance
Ignore the headlines, think global, and crunch these three often-overlooked numbers.
In 10 seconds
Knowing how to evaluate your investment performance and interpret market news can help you avoid costly mistakes. Don’t make decisions based on headlines. Focus on progress toward your goals and compare your performance to suitable benchmarks.
In 1 minute
As an investor, you want to make wise financial decisions. Naturally, a lot of people follow financial news to stay informed about what’s happening in the market. But if you’re chasing headlines, you might wind up making some common investment mistakes.
You might compare your portfolio to the wrong benchmarks. Or assume the market is performing better or worse than it actually is.
If you have a globally diversified portfolio, most financial news is just noise—and you’re better off tuning it out. Constantly buying and selling stocks may seem like the best way to beat the market, but a diversified portfolio will often perform better over a longer time. Frequent trading can leave you stuck paying short-term capital gains taxes that cut into your after-tax return.
Want to know how your portfolio is really doing? Instead of comparing your investments to a local benchmark like the Dow, S&P 500, or Russell 3000, consider using a global benchmark like the MSCI All Country World Index.
In 5 minutes
In this guide we’ll:
- Highlight the problems with reacting to financial news
- Explore a simulation about short-term investment decisions
- Explain a better way to evaluate your performance
As an investor, it’s easy to get caught up in the noise about the US market. But constantly reacting to the news and attempting to time the market will probably hurt your performance.
Want a better shot at reaching your financial goals? Don’t make decisions based on headlines. And if you have a globally diversified portfolio—like one with Betterment—avoid the trap of using US stocks as a baseline.
Caution: following financial news can lead to bad decisions
You can’t completely avoid news about the financial markets. The challenge is to know when to react and when to leave your investments alone. As you follow the buzz, here are three fallacies to avoid.
1. The Dow Fallacy
Benchmarks like the Dow Jones Industrial Average are popular, but they don’t actually tell you much about the stock market. The Dow only represents 30 US stocks. And even larger benchmarks like the S&P 500 don’t give you a full picture of the US market—let alone the global market.
2. The Points Fallacy
It’s common to hear reporters and investors talk about how many points a benchmark has dropped. Headlines like “Dow loses 500 points” sound pretty unsettling. And they’re meant to be. But points alone don’t tell you much. It’s far more valuable to look at the percentage. If the Dow is at 35,000 points, a 500 point drop is less than 2 percent. That’s not something long-term investors need to worry about.
3. The Urgency Fallacy
News writers often use overly urgent and dramatic language to grab your attention. Headlines like “Dow Jones Plunges” or “The Five Hottest Stocks to Invest in Today” may get more views, but they won't necessarily help you make good financial decisions.
It’s true: the market changes quickly. But if you do what every headline seems to tell you, odds are you’ll actually see worse performance.
Can you beat the market with better timing?
News headlines would often have you believe that with the right timing, you can beat the market. But is it true? Can savvy market timing beat a buy-and-hold strategy with a diversified portfolio?
Market timing almost never works in your favor, especially based on headlines. Instead of trying to time the market, you’re better off trying to maximize your time in the market. Even if you manage to get a win now and then, a globally diversified portfolio and a buy-and-hold strategy typically makes more consistent gains that pay off over time.
Not to mention, when you sell stocks you’ve held for less than 12 months, you have to pay short-term capital gains taxes. These eat into your margins fast, reduce the impact of compound interest, and can dramatically change your total returns. When you consider after-tax returns, market timing will almost always lose to a hands-off approach with a diversified portfolio.
How to evaluate your investment performance
Whether you’ve been trying to time the market or maximize your time in the market, you want to know how your portfolio is actually doing and if you’re on track to reach your goals. Unfortunately, you can’t just look at your earnings.
Accurately measuring your progress means adjusting for three crucial variables:
The Federal Reserve publishes inflation data, so you can adjust your total returns based on annual inflation. Reinvested dividends can make a big impact over time. And taxes vary by individual and account type. These factors make a big difference when it comes to measuring performance.
But what if you want to know how you’re performing relative to the market? Instead of falling into The Dow Fallacy, your best bet is to benchmark against the MSCI All Country World Index. It’s a much better representation of how the entire market is doing, so you can get a clearer picture of how your portfolio has performed.