Why You Shouldn’t Compare Portfolios

A couple of days ago, I was browsing through a random investing forum where people were comparing their portfolio performance.

As always, some were doing fantastically well, while others had less-than-desirable returns. Nothing new there.

What prompted me to write this text was that some of those who didn’t do so well started to consider investing in the same stocks that the people with higher returns.

That got me thinking that maybe comparing portfolio returns and investment returns overall is not such a great idea after all.

So, here are a couple of reasons why you shouldn’t necessarily compare portfolios with other investors.

Different Investors Have Different Strategies and Goals

The first and most compelling reason why you shouldn’t compare portfolios with others is that investors are different. They may have different risk tolerances, hold different asset classes, or they may have different investment goals overall.

Even comparing two stock-based portfolios might not make much sense.

There’s no point in comparing a widely diversified portfolio of mutual funds or index funds to a focused portfolio of individual small cap stocks, for example.

Or, as a long-term investor, there’s no point in comparing portfolios with someone who has a shorter time horizon.

Different investors also have different goals.

For some, the goal of investing is to maintain their wealth at a low risk level, and maybe achieve small returns on the side. For others, it’s all about aggressive accumulation, and for the rest, it’s something in between.

Therefore, before you compare your portfolio’s performance to someone else’s you should know what their investing goals are.

Stocks Aren’t the Same for Everyone

As Morgan House pointed out in his outstanding book, The Psychology of Money, stocks aren’t the same for everyone.

The same stock can be a poor or an outstanding investment, depending on your investment strategy.

How so? Well, imagine a growth stock with an extremely high price volatility that ends up going bankrupt in six months.

For a long-term investor, this would be a horrible investment. For a day trader who bases his trades on stock prices and trades on up and downswings, it can be extremely lucrative.  

Overall, if you blindly compare your stock picks to someone else’s without knowing what kind of an investor they are, it may lead to hasty and unfavourable investment decisions.

If someone’s holding a certain stock in their portfolio, it by no means indicates you should own it too.

Fear of Missing Out

If there’s one, almost guaranteed consequence you will get from comparing portfolios is the fear of missing out.

Imagine comparing your portfolio to someone who’s hit the jackpot with a bunch of aggressive, high-risk growth stocks that have offered tremendous returns. The temptation to get in on action is almost irresistible.

Unfortunately, the fear of missing out often leads to actually missing out. Many investors focus on chasing returns while forgetting that past performance can’t be used to predict the future.

The chances are that when you buy the same stocks, the greatest returns have already been reaped. What you’re left with are highly valuated stocks that need to get everything right to just maintain their valuation. In other words, the risk level is high, and expected returns are low.

So, when you compare your portfolio, you’re basically examining someone’s past performance, which can be misleading. Just because certain stocks have gone up, doesn’t mean it has any informational value to you.

Nor is it necessarily a cause to alter anything in your portfolio since some investment strategies work better in certain market conditions than others. This brings me to my next point about investment strategies.

There’s No Holy Grail

No matter what you invest in, growth stocks, value stocks, bonds, stocks, gold, or whatever, you won’t do well all the time.

There’s not a single investment strategy that offers the best returns in all market conditions.

Some portfolios do extremely well during bear markets, and others have outstanding performance during bull markets. It also depends on your asset allocation. Some assets do better in certain times than other asset classes.

The trick is to realize that when you’re comparing your portfolio’s returns to someone else’s, the chances are they have enjoyed tremendous returns in the short-term past but won’t do so well once there’s a chance in the stock market cycle.

Different Risk Tolerances

When it comes to investing, the biggest returns are usually made by taking greater risks. Taking massive amounts of risk doesn’t by no means guarantee higher returns, but a suitable amount will enable them.  

Therefore, it’s essential to match your expectations to your risk tolerance. If you’re not willing to take any risk, you can’t expect the highest of returns.

It’s also the reason why you shouldn’t compare portfolios with someone without knowing their risk profile. Because you’re entirely different investors, it makes little sense to compare your results.

Moreover, it can even be harmful. Comparing portfolios and the good old fear of missing out can lead to unwarranted alterations in your investment strategy.

A risk-averse investor would most likely become a nervous wreck holding a high-risk portfolio. Conversely, an investor with a high tolerance for risk would be severely disappointed in returns granted by a low-risk portfolio in the long term.  

So, before we judge someone due to low returns or become jealous of other’s high returns, we should consider the possibility that their style of investing wouldn’t necessarily suit us in the first place.

In fact, one of the most important things for an investor is to define their risk profile correctly. If you have trouble defining your individual risk tolerance, you can always consult a certified financial planner to help you out!