Summer 2015 Performance vs. Results Which Do You Want

“There is nothing more deceptive than an obvious fact”

– Sherlock Holmes

If performance is your #1 investment goal, then the S&P 500 was a good place to invest last year. In 2014, the S&P 500 returned 13.7%, surpassing many money managers and hedge funds that compare themselves to the S&P 500. But is an S&P 500 ETF or index fund automatically the best place to invest? It depends on whether you want “performance” or “results.” In this newsletter I will explain how an investor can have “performance” but not get “results”, while investors who concentrate on “results” may have a better chance of getting both.

“When a man does not know what harbor he is making for, no wind is the right wind”

– Seneca

Before deciding which you prefer, it helps to define these two terms. From a financial standpoint, I define “performance” as making the portfolio’s rate of return the primary measure of success. In this manner of thinking, risk is a subordinate concern. Of course, “performance” can be negative as well as positive. For example, in 2008 the S&P 500 index was -37%. In contrast, I define “results” as making the achievement of one’s goals the primary measure of success. “Results” make a combination of performance and risk the measure of success.

Using my definitions, “performance” is therefore a percentage rate of return, and “results” are how much money you have to meet your individual goals. You can’t spend percentages, only money in your account.

I believe that investors, be they individuals, institutions or foundations, should focus on results. Is the portfolio generating the money necessary to meet your spending needs? (This should be your “personal benchmark.”) If so, the “percentage” return, i.e. “performance” is not the important benchmark. We tell clients that our goal is not to go “as fast as their financial car can go” (performance) but rather we want to go “at the speed we need to get you to your destination safely and without becoming carsick” (results). How fast we “drive” depends, among other things, on your needs, the amount of assets you have, when you need to get there and your comfort level. If you are young and have a smaller portfolio maybe going faster, i.e., taking more risk to get “performance”, may make sense. If you are older and have amassed a large portfolio, going faster may make less sense.

“Bet on the jockey not on the horse”

– Old Wall Street saying

Often implicit in the term “performance” is the higher the return, the better. Thus, the speed a car or portfolio is capable of tends to be emphasized more than driving skill. In today’s bull market, going as fast as you can and “beating the benchmark” seems like a reasonable goal because, to many, the stock market appears to be like a clear, straight and dry road. Of course, we all know these conditions are unlikely to last. Eventually, there will be economic “potholes” and curves, and unfortunately, we are rarely given advanced notice. Going 90 mph when one hits a pothole is not pretty. Going 90 mph yet still arriving safely is not justification for doing so either. Make no mistake, performance is important, though in the end, I believe it is results that matter most. Remember, it was the tortoise that won the race. Driving skill matters. Finding stocks that deliver results takes “driving” skill. Unfortunately, all 500 stocks in the S&P 500 index fund will not deliver results, in fact very few will.

When investors concentrate on “results,” performance is one of multiple goals. Some goals may even be contradictory to performance. For example, safety is often a higher priority than performance if one is trying to protect funds that are set aside for an imminent college tuition payment. To an older investor, diversification to lower risk may be a higher priority nearing retirement. To a young investor, diversification to reduce volatility may be a higher priority if a house down payment is imminent. Let me use a different analogy. When vehicle shopping, how fast it can go is usually not the #1 priority. One must first consider the proposed use of the vehicle. Is it to drive a short distance to the train station every day or to commute a long distance? Is it to transport children or building supplies? Which is most important, safety, cost or speed? The vehicle one ultimately chooses depends on one’s needs and priorities.

“The truth will set you free, but first it will make you miserable”

– James A. Garfield

All the attention to performance has created a classic stock market trap. During bull markets many investors become “relative” investors. Relative investors want to beat the benchmark. They want “performance.” Maybe they didn’t save sufficiently and need to “catch up.” Or maybe they just don’t want to “miss out.” However, during bear markets, many investors become “absolute” investors. For example, in 2008, Warren Buffett’s Berkshire Hathaway was down “only” 31.8% compared to down 37% for the S&P 500 index1.

“Absolute” investors don’t want less loss, they want no loss. They want “results.” A 37% loss requires a subsequent 59% gain to get back to breakeven. After 2008, it took four years just to get back to breakeven in the S&P 500 on a percentage (performance) basis. On a money (results) basis, recovering from a 37% loss near retirement when your portfolio may be worth more is psychologically (and arithmetically) more difficult than the same percentage loss at the beginning of your investing career even if the percentage to breakeven is the same. Many investors lost patience in the years following 2008, particularly amid talk of the “lost decade” for stocks (remember that phrase). “Don’t lose any more money” became the investor mantra. Consequently, many absolute investors moved to low yielding investments such as US Treasuries. Of course, this meant they had no chance to achieve that 59% gain to breakeven again. Alas, since the return of the bull market, “absolute” investors have reverted back to “relative” investors and the mantra “make more money” (performance) has returned. Thus, the relative/absolute market trap has been set again.

“To win confidence in advance of success is the most difficult accomplishment”

– Napoleon Bonaparte

Bull markets mesmerize investors with visions of “performance.” This distracts them from the more important job of focusing on “results,” such as paying tuitions, generating an income during retirement, or building a long-term portfolio.

The bull market is in full swing, and “performance” again appears, mistakenly in my opinion, to be many investors’ top priority. Yet, as I have reminded readers in the past, “don’t confuse brains with a bull market.” I believe that bull markets mesmerize investors with visions of “performance.” This distracts them from the more important job of focusing on “results,” such as paying tuitions, generating an income during retirement, or building a long-term portfolio. Like John Templeton, I believe bull markets are the best time for reflection. Note: The S&P 500 has never had seven consecutive years of earnings growth. This would be a record. Think about that before you chase performance. Remember that in the next bear market, your “performance” may beat the benchmark yet fall short of “results” that are important to you.

In summary, I would like to share one more analogy on the difference between “performance” and “results.” In golf, performance is measured by your score versus “par” (normally 72 strokes per 18 holes). While most professional golfers shoot 72 or below, most everyone else rarely (or never) performs nearly that well. Yet, millions of people around the world play golf. Why? The answer is because it allows them to be outside on a nice day with their friends, enjoying laughs and good times! That’s results!

So may I suggest that instead of worrying about “performance” (and everyone else’s performance), identify your goals and make “results” your top priority instead.

“The great enemy of the truth is very often not the lie, delicate, contrived and dishonest, but the myth, persistent, persuasive and unrealistic.”

- John F. Kennedy

Thoughts for Investors is a quarterly newsletter written for clients since 1997 by this author. The purpose is two-fold. First, it is meant to help explain the investment philosophy that guides the author’s approach to portfolio management. Second, it is meant to remind readers of important behavioral skills that the author believes are necessary to help them become successful investors. The author welcomes comments and criticisms, especially if they can be shared for the betterment of all investors. Quotation is permitted with full attribution.