Investment Performance: Irrational Comparisons Lead To Investing Misery

It can be counter-productive to measure your investment performance against a benchmark (your relative return). Measuring relative returns often cause emotional stress resulting in decisions that damage investment returns. For example, if you outperform a benchmark by 40% in one year, you may presume that your investment is too expensive and sell your shares, just to see the investment continue to rise; or you may underperform the benchmark by 40% in one year, you may presume your investment is doomed to failure and sell it, just to see the benchmark crash.

Understanding your absolute return goals and your relative return expectations are vital when considering investment performance.

To explain in simple terms, if we bought one share valued at $100 in January 2015 and in a year’s time that share was trading at $110, we have an absolute return of 10% on that share. The relative return would be calculated by comparing the value of the share with a benchmark, another share or a market index for example. So if there had been a general downturn in the market and most shares had declined in value, a 10% return would be great. However, if we were in a bull market and our chosen benchmark had grown 20%, then our share would have had a negative relative return.

In both scenarios, we make the same money but are likely to feel differently about the result.

So, why do people feel compelled to make comparisons if the absolute return is identical?

As it turns out, humans make social comparisons of all kinds.

We are hardwired to engage in comparisons. That is, we can’t get away from it, and we’re doing it to try to make sense of our world. Do I make enough money? Do I need to update my kitchen? Do I need a new car? Are my kids doing well? It’s almost impossible to make those assessments objectively. So instead, we turn to comparisons.

Adam Galinsky and Maurice Schweitzer, both social psychologists and co-authors of the new book “Friend and Foe: When to Cooperate, When to Compete, and How to Succeed at Both.”

It is essential for you to understand this human trait to ensure it does not divert you from your investment plan to chase relative returns. Prices will fluctuate and markets will have bull runs or bear crashes, it would be a common but unwise action to sell your shares when things don’t seem to grow the way you expect. Keep a clear, unemotional head and measure your investment performance against your goals and the absolute investment performance. It is human nature to wonder and be envious when the prices of your peer’s shares are rising faster than your shares. But as Charlie Munger put it:

The idea of caring that someone is making money faster [than you are] is one of the deadly sins. Envy is a really stupid sin because it’s the only one you could never possibly have any fun at. There’s a lot of pain and no fun. Why would you want to get on that trolley?”

It is this fluctuation and comparison of relative returns that often causes investors to sell shares when they should be buying and worse still, buy shares when the prices are climbing. The key factor to consider when buying a share is the value of the company and its prospects to grow over the long term – in other words, the potential absolute investment return over time.

The best way to measure your investing success is not by whether you’re beating the market but by whether you’ve put in place a financial plan and a behavioral discipline that are likely to get you where you want to go. In the end, what matters isn’t crossing the finish line before anybody else but just making sure that you do cross it.

Benjamin Graham, The Intelligent Investor

So, if “comparison is the thief of joy” as Theodore Roosevelt once said, don’t let inconsistent and irrational comparison’s undermine your long-term investment strategy and rob you of the reward and joy of absolute returns!

Our investment goal is to turn our current capital into an annual dividend. We focus on absolute return, by measuring how our dividend income is growing. We do not measure the relative growth return of the growth of our capital against a benchmark.

Speak to our fund manager about setting goals and making good investment decisions and effectively judging your investment performance and follow us on twitter for more worldly investment wisdom.