Richard calculates the annual performance of his portfolio going back 13 years. One good or bad year tells us nothing about the skill of an investor, he says. If you had a bad one, do not beat yourself up about it.
Happy New Year!
I am kicking this year off on a bum note, talking about 2022, a year in which I not only lost money in the stockmarket but lost more money than ever before.
A lot happened in 2022. Russia invaded Ukraine, China intermittently locked regions down, and we experienced shortages and inflation the likes of which test even my memory. At home, two prime ministers were booted unceremoniously out of office and we experienced a mini-financial crisis. Shares in high-quality companies were hit hard because they were valued most extravagantly.
Somewhere in amongst all that, there is probably an explanation for why my shares lost value, but none of it was obvious last January except perhaps that good companies were trading at high share prices relative to their profits, which is an occupational hazard.
To me, 2022 was just as irrelevant as any other year.
To illustrate, I have done something I hated doing in the hope that it might provide succour to any despondent readers. Maybe it was just another year for you too.
For the first time, I calculated the annual performance of the Share Sleuth portfolio for every full year it has existed. Share Sleuth is a model portfolio I run for the investment platform Interactive Investor. I keep track of it in SharePad and although no money changes hands, all the trades, fees, stamp duty, and dividends are accounted for as though they were real.
I own all the constituents of the Share Sleuth portfolio myself, so I lost money too.
Happily, SharePad’s Transactions tab can calculate portfolio performance between any two dates*, which has enabled me to compile a table showing the performance of Share Sleuth, the performance of a same-sized initial investment in the accumulation units of a FTSE All-Share index tracker, and the difference between the portfolio’s annual return and the index tracker’s:
Source: SharePad. NB: 2022 return is for the year to 23 December.
Normally, I disregard annual performance numbers because I aim to own shares for as long as I live. Examining the performance of the portfolio over one year would only be useful if there was an obvious relationship between how it does in one year and how it does over, say ten or more.
But if you were to look at how I did in 2015 when Share Sleuth beat the market by 30%, or 2020 when the portfolio followed a 29% excess return with a 25% outperformance, you might conclude I am an extraordinary investor.
Now look at 2011 and 2012 when the portfolio lost out to an index tracker for two years in a row, or 2022, when the portfolio’s performance was 16% below the index tracker, and you might put me closer to the clueless end of the spectrum.
Drawing conclusions about an investor’s skill from any single year is about as predictive as reading tea leaves, and that may be doing tea leaves a disservice.
The column at the far end of the table shows that the compounded outperformance of the Share Sleuth portfolio is good. Over thirteen years it has beaten the index tracker by a factor of nearly five.
Is this because of skill? Could a 13-year outperformance be lucky? It could be, but I am more willing to believe it is significant than I am to believe a one-year performance means anything at all.
In his book “Investing Against The Tide” Anthony Bolton, a famous and mostly successful fund manager, said:
“I’ve always thought that the best environment in which a fund manager could perform well was one in which they didn’t know how they were doing. Unfortunately, the real world is the opposite of this, and every manager is only too well aware of how they are doing day to day, week to week, and month to month. The pressure – when it’s not going well – is intense.”
Fund managers worry they will lose their jobs if they do not perform in the short run. Clients will take their money out of the funds and the managers and the companies they work for will earn less money.
My concern is not for the managers’ bonuses or jobs, but for the clients’ returns. The incentives nudge fund managers to ensure they do not perform poorly by holding shares in similar proportions to the benchmarks they compare themselves to. If they do that, they cannot beat the benchmarks over the long term.
Private investors do not have this problem. We are investing our own money, not other people’s, so we only answer to ourselves. The pressure comes from within, and if we worry about the performance of our shares in the short term, we may also compromise our long-term returns by giving up on good investments in favour of shares that are rising in price now.
The answer for the long-term investor is not to focus on share price performance, as I have reluctantly done in this article, but to focus on something less volatile, which is what I do every other day of my investment career.
One option is dividends. Dividend payouts are less volatile than share prices so if your main concern is the income you are raking in and you have picked companies with safe dividends, you are going to be disappointed less often.
I do not take the dividend approach. I focus on understanding the businesses I have invested in: how they make money, how they might make more, and what could stop them. I monitor their performance in terms of profitability and growth and I am happy as long as it conforms to my expectations, irrespective of what is happening to share prices.
So if you are a long-term investor, my New Year’s wish for you is not that you never have a bad year, which would be nice but improbable.
It is that when you do, it does not throw you off your stride.
*If you want to try this for yourself, bear in mind things will get a lot more complicated if you have taken money out of your portfolio or put money into it since you formed it.
Contact Richard Beddard by email: firstname.lastname@example.org or on Twitter: @RichardBeddard
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This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.