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A Short Story to tell why You shouldn’t Compare Your Portfolio Returns with Index Returns

There is a general trend to compare your portfolio returns with returns of popular indices like Sensex and Nifty. And this is not a recent phenomenon. It has been going on since years. Ask anyone and they will tell you that their portfolios have beaten Sensex by 5% or 10% year on year.

Here is a short but interesting story about why it doesn’t make much sense to do it:

Years back, there was a man searching for something under a streetlight. A policeman comes by and asks what he’s lost. The man replies that his keys are missing and he can’t get back into his house.

After a few minutes searching together, the policeman inquires whether the man is sure he lost his keys under the lamp.

No, the man replies, he lost them in the park.

“Then why are we searching here?” exclaims the officer.

“This is where the light is,” replies the man, continuing to search.

Story Investing Street Lights

That is the end of the story. Can’t get it?

Don’t worry. Read further…

The problem with evaluating relative performances is that you can’t get much out of relativity, i.e. you can’t eat relative performance. And the biggest problem with relative performances is that it ignores what an investor actually needs? Some investors invest for growth. Others might invest for generating dividend income. And many like me invest for a combination of the two. 

And comparing short term relative performances when you are investing for longer time horizons like 5 or more years does not make much sense.

And an index is not designed keeping in mind an individual investor’s needs. Remember that. So if you are comparing your portfolio performance with that of an index, then remember that index does not know that you use it (and not your actual needs) to judge your portfolio performance.

So if you really want to find your lost keys, you need to look where you’ve lost them, not where the light is (index performance). And if you want to know how your portfolio is doing, compare it to your actual needs and not any arbitrary index.

Note 1 – The idea for this post is sourced from here.

Note 2 – If you want  to read another interesting story about monkeys & goats and what they tell about stock markets, then you can read it here.

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Written by Dev Ashish

Founder - Stable Investor Investing | Personal Finance | Financial Planning | Common Sense

5 comments

  1. There are lot of paradoxes here. Following is why I know why we compare:

    1. The index is (presumably) a combination of best 30/50 companies that India has.
    2. Therefore presumably we are comparing our performance with a basket of best 30/50 companies
    3. Doing so is basically telling yourself if it is worth to do all the research and invest your time in picking your set of portfolio or simply putting your money in an index fund (or giving it to a mutual fund?)
    4. We could also compare our performance with FD interest rate or other forms of investment but that in my opinion would be comparing apples and oranges
    5. Hence people compare – hence I compare – because we got to grade it relatively against something right? There has to be some basis to start with. Even calculating percentage has '100' as an assumed relative. Otherwise let us all put our money in a 4% p.a. savings a/c and burn it 🙂
    6. If one goes through enough financial documentaries then we can easily conclude that the whole financial system is just a scam (also read the same in one of your previous articles) – but we nevertheless have to take some basic assumptions and walk forward from there – throwing all general notions in to the dustbin just because the general public believes in it just leads us nowhere.
    7. Lastly, there are enough anecdotes in the internet to make anything and everything we currently know look stupid. But then as somebody said – if we remove all the flesh around the bone then the reason why we are here is to make money – compare to the index – don't compare – live in the real world – live in a hypothetical world of your own – we are basically here to make money .. and that my friend is the truth the whole truth and nothing but the truth – so help us all god! 🙂

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