Why Beating The Index Is Something That Shouldn’t Matter To You?
Ever had this feeling of frustration when your portfolio is underperforming the index?
If you answered yes to that, let me tell you that you don’t need to beat the index. I’ll go about in detail as to why I say so, in this article. So stick around.
A Tale of Two Friends
Let’s look at the story of two friends — Abu and Babu. Both of them have got a job together. Since Babu knew a little about compounding, he decided to start SIP in an equity fund. He also convinced Abu to do so. Both of them started their SIP of ₹5,000 in a large-cap mutual fund. Also, they decided to hike their SIP by 10% every year.
They were 5 years into their SIPs, and then came the big crash in March 2020. They both had invested a total of ₹3,67,500 and their investments were down to around ₹3 lakh — a “loss” of ₹67 thousand. In fact, their fund had even underperformed the index during this time.
Abu is worried that even after having patience for 5 years, not only does he have to bear losses, but has also failed to beat the index. He curses his decision and thinks that it would have been better if he would have kept his money in fixed deposits. Finally, he decides to sell his mutual fund holdings in the loss.
On the other hand, Babu is unaffected by the loss, and also unaffected by the fact that he has underperformed the index. He decides to continue his ongoing SIP. Fast forward one year, he has around ₹4.5 lakh invested and his corpus is over ₹6.5 lakh. Yes, he has still underperformed the index (just marginally). But, his fund outperformed the index over the last year.
The most important question is would Babu really care? Not at all, as long he is on track to achieve his financial goals. Babu knows that it is not possible for any mutual fund to outperform the index over all time frames. Sometimes it might underperform, the other times it might outperform — it is just a part of the game. I had covered this previously in a guide to selecting winning mutual funds.
Beat Inflation, Not The Market
Many people measure their performance of their portfolio against the broader market primarily because it is readily available. If you want to have a benchmark, it should be inflation. That is the biggest killer of purchasing power. If you own solid businesses at fair prices, you are bound to beat inflation. I have covered more about these in my free guide.
Whether these businesses beat the index or not, that is to be seen. Beating the index should be none of your concern. What difference does it make if you are reaching your goals on time, but have underperformed the index?
The biggest benchmark that you must follow is your own financial goals. When you are in your accumulation phase (i.e. investing), your primary concern should be, “How close am I to achieve my financial goals?”. For this, you can create a chart with the expected returns of how your portfolio would grow? This would be a smooth exponential curve. Now you can plot the actual value of your portfolio.
Always ask, “Am I beating this benchmark?”. It is given that sometimes you might underperform this as well. But, will you be able to reach all of your goals on time? That is the question that you must be asking yourself.
When you have stopped earning, and would now be withdrawing on your corpus, plot a similar chart that shows how the portfolio would move during your withdrawals. And then, plot the actual curve. Ask, “Is my portfolio beating inflation?”.
You don’t need to beat the index. The only two things you need to care about are whether you would be reaching your goals on time, and inflation. That’s it. Your portfolio underperforming shouldn’t bother you. To stay sane, become debt-free, build an emergency fund, and stay consistent with your investments. The markets will definitely reward you.
Till next time.