The stock market had a great year in 2017, with the S&P 500 rising more than 19 percent. Did your portfolio do as well? If not, you may feel like you missed out. You may even be tempted to make some changes, going all in on headline-making companies that did well in 2017.
But hold on. Just as scrolling through your social media feed can make you feel like you need to up your vacation game, reading about hot investments can tempt you to invest reactively instead of proactively, and that often does more harm than good.
What’s a person with investment envy to do? Read on.
1. Keep hot investments in perspective
If you pay any attention to investment news, you’ve seen plenty of headlines about the so-called FANG stocks, an acronym that represents Facebook, Amazon, Netflix, and Google (Alphabet). Other popular consumer-oriented companies include Apple and Microsoft. Each stock had a great 2017.
Should those investments be part of your portfolio? Maybe, but the principles of wise investing would suggest buying them only as part of a diversified portfolio and only if you understand that what goes up quickly can also come down quickly.
For example, in 2008, when the S&P 500 fell 38 percent, many of these hot stocks also plummeted — some by more than 50 percent. (See also: 9 Ways to Tell If a Stock is Worth Buying)
2. Keep a hot market in perspective
At the end of each weekday, there are news reports about how “the market” performed. In reality, such reports are usually about how the S&P 500 or Dow Jones industrial average performed. Both are stock market indexes, but both are designed very differently — the S&P 500 represents the collective performance of 500 of the largest U.S.-based public companies, and the Dow represents just 30 companies.
The only investors for whom it would be fair to benchmark their portfolios against such indexes are those who invest solely in an S&P 500 or Dow index fund.
If you have other investments in your portfolio, you need to remember that “the market” is not the same thing as your particular portfolio. It’s fine to view the market’s performance as a general investing barometer. Just don’t be envious if your portfolio doesn’t perform as well, or overly confident if it performs better. (See also: Want Your Investments to Do Better? Stop Watching the News)
3. Keep your benchmark in mind
The best point of comparison to use when evaluating your portfolio’s performance is a benchmark tailored to your age, goals, and risk tolerance. More specifically, it’s the average annual rate of return that’s part of your investment plan.
If you don’t have such a plan, it isn’t that difficult to create one. Begin by completing Vanguard’s investor questionnaire. It’ll suggest an optimal asset allocation. From there, you can review the historical performance of portfolios with various stock/bond allocations, which can help you choose a reasonable rate of return assumption for your own portfolio.
4. Get the best of both worlds
Once you know your optimal asset allocation, you can use index funds to create a diversified portfolio designed to share in some of the overall market gains, as well as the gains of individual hot investments.
In fact, just investing in an S&P 500 index fund enables you to do both. Of course, it gives you exposure to “the market” as defined by that index. But it also gives what may sound like a surprising level of exposure to the fast-growing individual stocks mentioned earlier.
You see, the S&P 500 is a “market capitalization-weighted” index, meaning each company that’s included is represented based on the value of its outstanding shares. Because Apple, Alphabet, Microsoft, Facebook, and Amazon have done so well in recent years, they make up a disproportionate share of the index. For example, those five stocks account for nearly 13 percent of the Vanguard S&P 500 index fund, VOO.
However, even if your optimal asset allocation is 100 percent stocks, you’ll probably want to diversify beyond an S&P 500 mutual fund, perhaps including smaller companies through an extended market fund, and foreign companies through an international fund.
Benchmarking your portfolio against headlines about this fast-growing sector or that hot investment will just cause you stress and may even hurt your returns. Instead, develop and follow a plan that includes a realistic assumed average annual return based on your circumstances and goals.
Using the right benchmark will do wonders for your portfolio and your peace of mind.