2022 Review: Winning in a Losing Year 

January 2023 Newsletter

2022 was a bad year for investors. By the end of the year, the market was down almost 19.5%. People are typically much more affected by a negative year in the market than by an equivalent positive year.  Losing has a much stronger emotion attached to it than winning, it’s human nature. Losing years make people want to give up and get out of the market… But don’t! Hold tight!  Keep in mind that average long-term stock returns are positive at about 9% and this number includes the bad years. Small investors often make an emotional exit from the market as it falls, and later try to get back in when it goes up. The problem is that trying to time the market requires knowing 2 impossible things: when to get out; and when to get back in. It’s a sure way to sell low and buy high.  The market historically punishes those who try to implement this emotional strategy.

I’m going to let you in on a little secret that might make you feel better. You can still win in a losing year. Yes… even if you’ve lost money. The game is one of relativity, not Einstein’s version… but financial relativity.

What is Financial Relativity?

In my last article, I mentioned that I play the relativity game. In other words,  I measure my success in the stock market relative to a market index. My hobby portfolio beat the market (again) in 2022 and I consider that a huge relative win. I still lost money and yes, that feels bad, but I look at the big picture and the long game. A relative win, even in a down year, is a big deal because it adds to the annual compounding effect that will yield benefits in later years.

Most investors are quick to write off a bad year without reflecting on their relative performance, they would rather just ignore that it happened.  Unfortunately, it’s often the same situation in a good year; a positive return feels good and can mask bad performance. You may have gained 15% in a year but if the market returned more, then you are a relative loser.

Arguments Against Financial Relativity

I love comparing my performance to an index because it establishes a goal and helps me to determine if I am making good decisions. However, there are investors who suggest that making comparisons to a market index is irrelevant.  Their argument is that if they are happy with their returns, who cares how the market performed. They are simply trying to achieve a positive return, no matter what the market does. They do their own thing.   

The strongest argument comes from those investors who prefer to position their portfolio in a manner that allows them to be comfortable with the amount of risk for their expected reward.  These investors are not necessarily after market-like returns, they are after an efficient return for the amount of risk exposure. A good example would be an investor who has determined that the market is risky and only holds dividends and big blue chip companies. They would prefer to underperform the market purposely with a much safer portfolio. They may even hold underperforming bonds and gold to avoid risk. They don’t care how the market performs relative to them, because they are playing a different game.  Some do it so well that they can achieve exceptional returns.

So, there are some valid reasons to avoid comparing to an index and I believe some advanced investors can make good risk-reward choices and achieve a return that is informed and acceptable.  In fact, this is the Warren Buffett way. He doesn’t care what the market is doing.  He does his own thing and his returns are different from the market’s… and in the long run, he does really well. 

Arguments for Financial Relativity

Investing decisions, like other life decisions, are about choice.  Your choices will yield different outcomes; some good and some bad.  In investing, you could choose to hire a financial advisor, purchase a market ETF (Exchange Traded Fund), or custom pick your own stocks. You could also choose to invest in more tangible things such as art, a house, your own business, or fine wines. The outcome of each choice can be measured against the outcome of other choices.  Making comparisons based on outcomes is the best way to determine if you are making good or bad investment decisions. It’s worth noting that even though Warren Buffet doesn’t invest based on the market, he is only considered great because he is measured against the index. As long as there is a choice, there is relativity.  You’re best to make your investment decisions based on what will yield the best relative performance.

There’s no right answer, just the one that works for you. However, I believe that most small investors are best served by using a relative (comparative) approach.  The “I do not care what the market does” attitude generally masks bad behaviour and performance.  Most small investors do poorly in the long run, even though they are trying to achieve market-like performance.  By comparing to an index, investors can have a better understanding of how well they are doing and if they need to change course.

Be Like the Market

If you’re going to compare your returns to a benchmark like a market index, you need to be like the market index.  In other words, your portfolio should be built with similar market sector weightings.  Good market indexes are a reflection of the economy, they are naturally diversified based on the biggest, most successful companies.  If your portfolio has a similar weighting of Technology, Communication, Energy etc. to the index, it’s hard not to achieve a similar return. This is important because it provides some certainty for a market-like return, which is approximately 9% long-term.  “Doing your own thing” and having a “different” portfolio, like Warren, guarantees a different return. Most small investors attempting to be the next Warren Buffett also have a “different” portfolio, except their returns are mostly bad different. Do not try to be Warren Buffett, he is an outlier.  

Which Index Should You Benchmark?

In a diversified world, picking a benchmark index is complicated. To keep things simple, I have chosen to use the S&P 500, because the majority of my positions are American.  However, there is an argument to compare my Canadian stocks to the TSX 300, and my international stocks against the MSCI world index.  If I had a fixed income, I would compare it to a Bond index.  There is no perfect answer but I would recommend looking toward one or two indexes that best represent your portfolio.

It’s Time to Measure Your Performance

As it’s the end of the year, it’s customary for me to challenge you to measure your annual performance.  If you are achieving market-like returns, then congratulations, you are definitely in the over-90 percentile group.  If you have unfortunately murdered a lot of your money, (again?), then maybe it’s time to revisit your choices, because everything is relative. If you are happy with not comparing and you like doing your own thing, who am I to argue against happiness 😉

A Note About Performance

If you agree with my pitch about relative returns, then you agree that you can still win in a losing year.  That also means that you can lose in a winning year.  To complicate things further, performance is not always causal to your decisions. Perhaps you beat the market with your 1-stock pick – a company that happened to discover gold under their parking lot.  That is just plain luck, not market genius. It’s easy to mistake good luck for skill and bad luck for poor decision-making. It’s important to understand why your returns did or didn’t perform well.

Marc’s Monthly Moves

• Nada.

Marc’s Portfolio End-of-Year Performance

My portfolio page is LIVE! I will continue to update it monthly. It contains a full list of my positions and the performance information that I’ve included below.

• Portfolio return: -4.85% (including currency gains)
• Portfolio return: -11.85% (without currency gains)
• S&P 500 return: -19.44%
• TSX: -8.66%

The portfolio overperformed the S&P 500 by 7.6 percentage points.

Happy investing.
M