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.
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 in a portfolio of stocks and live off 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.