Wednesday, April 13, 2016

Why relative performance comparisons provide no value to me

As a dividend growth investor, my goal is to generate a certain amount of money that would pay for my expenses in retirement. I work to achieve this goal by creating a portfolio of companies that include certain characteristics such as a track record of dividend growth exceeding a decade, good valuation, decent growth prospects, strong brands and strong competitive advantages etc. I evaluate my progress by comparing the amount of dividend income that covers my expenses. Right now, my dividend income is expected to cover 83% of expenses on the low end of annual expenses and 63% at the high end of my expenses. However, I do not track my total returns, which irritates many out there. But I couldn't care less.

I believe that tracking my total return is a waste of time. This is because based on the studies I have read, and the data I have seen, a diversified portfolio of stocks will likely get a similar total return to what the so called market would get. Plus, if I “underperform” some benchmark over a short period of time, I would feel the pressure “to do something”, which goes against the tenet of reducing portfolio turnover. And believe me, the pressure to switch to some other strategy will be highest after a stock has gone nowhere for a while, causing you and everyone else to doubt your abilities.

For example,the stock price of McDonald's (MCD) had gone nowhere since the beginning of 2012. Plenty of investors were starting to get worried as a result of this. Newspapers, magazines and blogs were predicting the demise of McDonald's, as millennials supposedly didn't like its greasy food. Little in the form of research was shown to provide any support that people didn't like McDonald's anymore. But the stories and speculation to fill in media space were present nevertheless. Fear sells. I believed that the company will persevere, and I stated so in my analysis of McDonald's from 2015.

As I mentioned above, an investor is more likely to doubt themselves after a few years of "underperformance". Which is precisely why as a small investor I ignore performance benchmarking. I know that over the next 20 - 30 years my returns will be close to that of any group of US stocks. Whether I beat a group of participants in 10 out of 15 years is irrelevant to my goals. To reiterate, my goals are to earn enough dividends to live off in retirement. It is important to have enough, and to not fall for a rat race at work or in investing.

For example, if I had sold McDonald’s (MCD) in 2015 to buy S&P 500 index fund, because the stock price had gone nowhere, I would have lost out on all the upward compounding since then. And knowing investors, I can tell you that the time they would have sold would have been in 2014- 2015 when everyone was predicting the end of McDonald’s (MCD). Let’s see how that worked out, shall we? (the example below excludes dividends for the S&P 500 fund and excludes dividends from McDonald's therefore somewhat discounting the better return of the fast-food giant)

As I have said hundreds of times on this site, I am mostly focused on building out a sustainable stream of dividend income for retirement. I am choosing to focus on dividends, because they are more sustainable than capital gains. The amount and timing of dividends is easier to predict and live off, than the amount and timing of capital gains. Therefore, it makes perfect sense to focus on dividend income, and ignore the crazy stock price fluctuations, knowing that at the end of the day I am working towards reaching my own goals.

In my case, I stuck with McDonald's because I kept receiving a nice and growing amount of dividend income from the company. The quarterly dividend went from 61 cents/share in 2011 to 89 cents/share in 2016. I was receiving a 3.50% yield, and a dividend payment that grew above the rate of inflation, while patiently waiting for a turnaround. And when you are paid cold hard cash every 90 days, you can afford to be patient, because the company is "showing you the money".

The amount and timing of future returns is unpredictable. You may have a long a trying period of time, where stocks go nowhere for a decade. When stocks go nowhere for a decade, investors patience is severely tested. Only a person with nerves of steel will have the patience and perseverance to stick to their strategy during lean times. Only after the last impatient buyer sells, can you get some price appreciation.

When everyone talks about making 10%/year in stocks, they are forgetting to inform you that these are average annual returns over long periods of time. This average includes long periods of booms as well as long periods of little to show for your investing records. To add insult to injury, your mind will be playing tricks on you, telling you with is perfect 20/20 hindsight that you would have been better off, had you bought something else.

Most ordinary human beings would bail at the first sign of trouble. Therefore, instead of holding on to something that does poorly relative to something else that may be doing better, they sell and move on. This is a mistake, because as we mentioned above, the nature of stock market returns is lumpy. If you sell when things look depressed in order to buy something merely because it has done better, you are in effect selling low and buying high.

Full Disclosure: Long MCD

Relevant Articles:

Are you patient enough to become a successful dividend investor?
McDonald's (MCD) Dividend Stock Analysis 2015
How many individual stocks do I need to consider myself diversified?
What are your dividend investing goals?
Living off dividends in retirement


  1. From what I've read, a selected portfolio will most certainly underperform a broader stock benchmark over time--not match it. At least, almost no active fund manager apparently is able to beat the market for more than a few years.

    However, I feel total return is important to me only for significant differences. I would much rather exchange some total return for some reliability in income. If, 30 years from now, I've missed out on 20-30% of total return but sustained myself off a nicely growing dividend income so that I only have to think about selling stocks if there's a calamity, then I'll feel like I made a right call. Why? 20-30% total return can evaporate in a month--I don't want those kind of worries. I realize that the dividends can go down as well--but they apparently are much more stable than stock price (for the companies that have been paying decades, anyway).

    Thanks for all your articles--they're always thought provoking and help me keep my goals clear.

    1. Not to be too critical, but there is an important caveat to this oft-proclaimed truism. Active managers underperform after taking into account taxes and fees. However, the story is substantially different otherwise. As DGI and others like him tend to have very low portfolio turnover and keep fees low (transaction costs only, and these tend to be kept well under .5% for a onetime charge on cost basis alone, compared to at the barest minimum .05% ongoing on total value).

      A smaller caveat is the completely different investment horizon for DGI versus an active manager: quarters vs. decades. This changes the incentive structure tremendously. I'm not aware of any study examining this, but I believe most active managers would be able net-outperform "the market" over long periods of time if not encumbered by fees and short-term demands (not at the same time, of course, as "the market" would be different).

    2. Actually, the mutual fund companies have an incentive to show the average investor that they are an idiot. That's why there have been so many "studies" that try to prove how terrible investment performance for individual investors is. I take those "studies" with a lot of skepticism, because they are usually not comparing apples to apples or they pick and choose groups of investors that fit with their agenda.

      But I would be interested in seeing the studies you are quoting.

      Either way, as Unknown mentioned above, mutual funds on average tend to do as well as index funds. They do worse due to costs. If I hold AT&T, but someone charges me 2% annual fee, I would do much worse than the index fund that only charges me 0.10% to hold AT&T for me.

      I try to hold most of my stocks for years. Many DGI investors have held on to their stock for decades. Low turnover has lead to great results over time - Even the original 500 S&P stocks have done much better than the S&P 500 index.

  2. I think you're correct with respect to comparing your portfolio to a benchmark. Your past investment decisions are a sunk cost; something you cannot change. As long as you as progressing toward your stated goal of generating a stream of cash to cover your expenses, then I think you are right to tune out the noise.

    One the otherhand, there are low cost, tax efficient mutual funds that do the same thing. As you acknowledge, your total return is likely to converge to the performance of the overall market. If you had dependents say a spouse or children who would have to carry on in your absence, I think you might reconsider stock picking. To each his own.

    It's a fun blog to read to see other people's though processes.

    1. The important thing is to identify your goals, find a plan to reach those goals, and stick to it. If you move money from one investment to the other, because you are chasing past performance, you may end up disappointed.

      I would much rather select my own stocks, than have someone else do it for me. Plus, I select individual stocks to hold for decades.

      You pick mutual funds. So you are a mutual fund picker. Somehow, telling the truth to some really irritates them.

      And by the way, I have not found a mutual fund that "does the same thing" I am trying to accomplish. Please provide a factual example.

  3. Hey DGI, good post and it's a valid point to not be distracted by relative performance.

    I guess I'm a "numbers" nerd so tracking my relative performance is one of many metrics I track. That being said, it does not play a major role in my decisions.

    I have a chart showing the value of $1000 invested in the Dow, NAS and S&P versus ME since 1990. Interestingly, the NAS is the best performer at $12977, I'm at $10505, the Dow is at $6675 and the S&P is at $6201. The NAS typically doesn't have many good dividend stocks but when a group like the FANGs take off it's difficult to compete.

    Good luck and keep up the good work.


    1. I guess nerds tend to cluster around each other ;-)

      You have invested for much longer than I have. Thus, you probably have more credibility than 90% of investment bloggers out there, if you have invested since 1990. So perhaps, I should be reading your blog? ;-)

      Thanks for stopping by.

  4. Hey DGI,
    We often disagreed on this topic and I'm happy to read more about your thoughts. I believe it is very important to track my return and look at how it performs vs a benchmark. Plus, it takes me about 5 minutes per year, so it's not a big waste of time.
    Investing requires time and energy. An investor that doesn't look at financial statements and doesn't follow companies in his portfolio will eventually lose money. Therefore, if I have to spend time managing my portfolio, I want to make sure I'm doing a good job at it. If my goal is to build a portfolio paying a nice dividend to cover my expenses, I have 3 options: A) manage it myself, B) invest in a dividend paying ETF and C) invest in a dividend mutual funds. If I'm doing worse than option B and C, I'm wasting previous time I could use to do something else (spending time with friends and family or work more to earn more money and save it). I don't feel pressured if unperformed my benchmark for a year or two, but it is an indication that I should keep going or seriously think about leaving others managing my money. It doesn't influence my investment strategy (I actually made 5 purchases during the drop in January), but it tells me if I'm doing the right thing.
    Focusing too much on dividend payment could also be tricky. If you have $100,000 in your portfolio paying $5,000 per year and you save another $100,000 and your portfolio now pays $8,000 in dividend, your dividend payment did increased by 60% but that's because you increase your capital by 100%. The dividend growth rate is not that impressive all of a sudden.
    I currently track two things yearly: my investment return vs my benchmark and my dividend growth vs capital growth (new money invested). This takes me a few minutes per year, but gives exactly what I need to know: A) am I wasting money because I invest it by myself instead of leaving professional doing it, B) is my portfolio really increasing its dividend payment, or am I saving tons of money to let me think my portfolio is increasing its dividend payment.
    I've learned that results you get is results you measure. I guess this applies perfectly to the investment world.
    Thx for sharing your thoughts, I understand better why you are not tracking your results.

    1. Mike,

      So since MCD did worse than the market, did you sell it before it went up?

      If you did, you engaged in the type of behavior I am describing here. You sold low because you lost your patience, and bought something that has done better. This is actually called performance chasing, if I am not mistaken.

      The problem is, you can only measure your returns all you want, but there is not much about that you can do about future returns. There is no predictive correlation between past results and future results. So measuring your returns has zero use for your investment process.

      Past performance is not a guarantee for future results.

      Your other example about dividend growth has already been discussed in my article on organic dividend growth:

    2. Hey DGI,

      I actually sold MCD because I believe the company is not going to generate growth in the future. I made money when I sold MCD, therefore, it's definitely not about losing patience over a company or chasing market returns. The company simply didn't meet my investment principles anymore and I had better opportunities at that time. I think investors should look at their holdings and review them to make sure companies continue to meet their investment thesis.
      In fact, comparing each stock performance individually is not a good strategy at all. It's not because a company doesn't perform for 1, 2 or 3 years that it won't later on.
      I agree that past performance doesn't guarantee the future, but usually, when you are very bad at something for years, chances are you will continue to be bad at it for a while. The risk is that if you pick 10 companies like KMI in your portfolio, you be patient and you don't track your investment return, the only thing you are doing is being in denial ;-).
      Great post about organic dividend growth!

    3. If you track dividend income and 10 companies eliminate dividends say in 1 year, you will know you need some work to do. But if you look at performance relative to benchmark, you will increase your odds of selling low when you temporarily "underperform". Compounding errors can be very costly. I suggest you avoid at all costs.

      You will sell at the first sign of "trouble" when you compare to an index. This fails to account for the fact that Future returns and business performance are unpredictable. This is not smart investing.

      Actually, the biggest mistake investors make is lose patience and sell right before things turn around. They use different "reasons" for selling, but if they are really honest with themselves, they will admit to losing patience.

      You do not know whether the company's best days are over or not. Companies do not go up in a straight line, things grow, then consolidate, then grow again (or not). When you decided to sell, you made a judgment call which so far seems incorrect.

      Because we deal with imperfect information - you probably determined that MCD best days are over after reading about it and seeing that it temporarily went nowhere.

      Investment turnover is quite costly. Quite often, you are better off simply doing nothing.The point is, you are better off not trying to outguess where things go in the future.

      Your example with mcd shows that. You essentially missed out on 30-35 points of upside. And what did you buy with the proceeds from selling MCD?

      And i bet you bought something else that disnt do too well, and as a result you are worse off than simply staying put.

      If you do that 10 times in a row, you will not succeed in producing total returns or dividend income growth.

      I am not saying this to pick on you. I have made the mistake of selling and then buying something else. So i always come back to the point of selecting investments, and staying the course.

    4. Just some of my thoughts here DGI

      I think that thought is similar to something I said the other day. When investing according to your own plan you can do 1 of 3 things. Do nothing, make small changes to the plan, or revamp the plan. Most the time doing nothing is the best course of action. While making small changes can be warranted at times. Of course all of these are relative to the individual.

      When actually managing a company through a tough spot there must be small changes to the winning formula over time, while not diluting the cause of original success. This is what most successful companies do.

      As for tracking performance that is a personal decision for each person. Not sure why people come out at you for not doing it since it's your own prerogative. That's awesome you are meeting your goals with the formula you decided to follow. However when people track against a benchmark(as i do) its up to the individual to resist feeling pressured to perform better. I do it to keep myself humble and for competitive reasons. I don't want to ever think I'm the smartest person around, but I also love to see how long I can beat the benchmark everyone worships over time.

      Another important piece is to analyze past behavior. I've made plenty of mistakes myself through the years. An investor needs to go back and analyze past decisions to see if there was an error in judgement, and then try to learn from those mistakes.

      In all let the haters hate and let the cold hard cash speak for itself.

    5. I agree that you need to monitor your investments. And trying to improve over time is important.

      But looking at past performance in order to determine what the future performance will be, strikes me as something that doesn't produce any actionable information.

  5. I like to include the dividends in my rate of return. I DRIP all my dividends and I know exactly how much I have spent on buying stocks. My overall return is 31.46%. However, when I log into my account, it shows I have am up 20.46%. I just don't feel that is accurate, because I have received money from those stocks as dividends and so it should be included.

    1. That's because brokerages include dividends received in your cost basis.

      For example, if I bought 1 share of JNJ at $90, and received $3 in dividends that I reinvested at $100, the broker sees that I have 1.03 shares with a cost basis of $93.

  6. DGI,

    As always great post. People do bounce with early trouble; that is true of the cops showing up at a party and the stock market. Also true is that as small time investors our patience and willingness to play the long game are our best and strongest weapons. We are not the big funds or banks trying to turn a profit quarterly or daily even by buying and selling. Gordon Gecko was a cool figure for a movie, but that kind of quick movement trading can be and likely is destructive to my portfolio.

    Like the Jerry McGuire reference by the way,

    1. I think that patience is one of the traits that separates the successful investors from the unsuccessful ones.

      If you find a strategy you can stick to, no matter what happens, you will do better than everyone else over time ( since everyone else will be going from strategy to strategy, always looking for something that doesn't exist)

      In fact, if someone bought and held long-term CD's or bonds over the past 20 years, they probably did pretty well over time. As long as they stuck to their strategy.

  7. Yep DGI is about long term. As long as the dividend keeps increasing, why sell?

  8. Excellent post, very well thought out!

  9. My old MBA and Finance professors are going to label me a heretic but I'm on board with not tracking total return. The return that matters (especially to you) is the cash flows your portfolio produces. That is True Wealth. People in modern society have forgotten the original meaning of having a "nest egg" as we don't keep chickens any more. Originally, you kept one egg in the nest because it attracted the hens to lay more in that location. So a 'nest egg' isn't something you consume or draw down, it is an attractor of regular dividends.

    1. Right now, my dividends can cover between 63% to 83% of my expenses.

      I am on track to live off dividends in 2018. So I could not care less if I beat or miss relative to some benchmark that might have had a better past performance.

      But many people seem to be stuck in the rat race of trying to beat some benchmark. In order to retire, you do not need to beat any benchmark. You need to consistently save and invest.

  10. Hey DGI,

    I agree with your philosophy and the points you make. I dislike certain nuances about investing/returns/whatever you wish to call it.

    Whenever you track something over time, it assumes that you purchased at the start and SELL at the end. Any comparison of an increase in value of fund v DGI investing does not take into account that the fund only would receive that return IF they sold at that point (which invariably they haven't) whereas the dividends received are concrete and have been delivered as returns.

    I'd hope most people would agree that the current value of a business is the ability to make future profits. Those profits (unless re-invested) will be partially paid out in dividends. So again, the dividend is a concrete result of the increase of profit. If the profit (and dividend) looks like it is going to fall, so does the share price.

    There are many, many companies on stock exchanges that have not, do not and may not make profits that justify their price. Eg the major tech companies. In that situation people are trying to be company share price timers - timing when people will become more optimistic about the company's future. Amazon, as a profit creater, has been terrible.

    It is only companies that increase their revenue, profits, dividend and ability to produce further profits for the future that are worth following.


    1. Hi Tristan,

      Once the dividend is paid out to you, it is your to keep. A stock price can go from 90 to 130 and then back to 90. But we are after teh stable and growing dividend. One thing to remember is that companies do not grow to the sky in a straight fashion. So you need patience, because you do not know in advance whether some weakness is temporary or the beginning of the end. Noone does. But it is a safe bet that a company that has grown dividends for 30 years will experience some turbulence, but it also has good odds that it will be adapting as well.

      What many investors are doing is to lose patience when a stock stays between 90 to 100 for a few years, while the benchmark goes from say 90 to 120. After 3 years of stock price going nowhere, the news start publishing stories about "the end of the company", and those who have patiently waited for 3 years convince themselves they would have been better off in the benchmark that had done better. So those investors sell because they lost patience, and buy something else.

      Hence they end up selling low and buying high. After the last impatient seller sells, the stock price moves up.

      This is why I do not focus on meaningless stock price fluctuations, let alone fluctuations relative to other fluctuations. Yet everyone else seems to be doing it.

  11. "If you track dividend income and 10 companies eliminate dividends say in 1 year, you will know you need some work to do." I actually think you should quit instead of keeping hurting your portfolio ;-). That's my point: What's the difference between an investors who saves and invests $20,000 per year in a dividend oriented ETF and the investors who manages his portfolio by himself? Both will be able to live off their dividend. The main difference will happen if investor #2 can't make good decisions and focus on high dividend yield companies like KMI of this world. If #2 doesn't track his investment performance, he will never be aware that he is losing tons of money and energy while he could have simply invest in a dividend paying ETF like #1. That's why I track my performance; not to put pressure on my investment performance over the short term. But if you can't make good returns compare to ETF within 3-4 years, you will never make it. Therefore, investing becomes a costly hobby, nothing more.
    As for my MCD trade, the company PE ratio went from 19 went I sold to 26.50 today. Both revenues and earnings are declining and management struggles to find a way to generate growth for several years. If your business doesn't grow, you will not be able to increase your dividend payment at one point in time. This is why I sold MCD.
    Now, cherry picking one trade to see if I was right or wrong over a very short period of time is gambling. What if I tell you I made 50% on my other trade, would you tell me I did the right choice? I don't think so. It didn't happened with MCD as my next purchase didn't go as planned. However, I look at my overall portfolio performance last year (+8.8%) and I don't feel bad for making one mistake. We all do. The important point is to make less mistakes than good moves and to keep mistakes related to small investment (this transaction was was about 3% of my portfolio).
    "Actually, the biggest mistake investors make is lose patience and sell right before things turn around." I think we agree on this. The point is not to trade actively to chase returns. It simply to make sure that you actually can or can't add something to your portfolio as dividend ETF would do it for you without any efforts. In an ideal world, I would keep all my holdings forever. Unfortunately, businesses and economics evolve rapidly and several great companies today can become mediocre ones in 20 years from now.
    I love those discussion, I thin I learn when I discuss with people who are not thinking like me. Thank you for bringing another point of view.

    1. "But if you can't make good returns compare to ETF within 3-4 years, you will never make it."

      I disagree with you. I also disagree that you should quit cold turkey. Many investors quit in 2008 - 2009, and all they did was lock in their losses and run away. Your comments seem to suggest just that. You also assume that dividend investors are complete dummies. Is that how you see other dividend investors? It seems like this is your central thesis.

      Your main thesis is because of strong past returns in an ETF relative to your portfolio, you should sell low because you lost patience after an arbitrary period of time.

      But then you agree that past performance is not an indication of future returns.

      So in essence, you are very likely agreeing to sell low for no apparent reason than performance chasing. And this will not serve you well in the long term.

      I do agree that you need to monitor investments. But I disagree that you should actively do much trading within a portfolio.

      I did not cherry pick anything. I used an actual example where someone had told me to sell in 2014 - 2015. Looking back at your site, you never told me to sell KMI, so you cannot use it in your example ( you are cherry picking as well). I find it extremely sad that you are the one who read my article, and had actually made the mistake I discussed, and yet you are in complete denial that you made a mistake.

      I am not going continue this conversation with you any more, because it is wasting my time. I do not want to waste my time going back and forth on this topic. Everything I have to say, I have said it.

      Either way, I wish you good luck!

    2. Just so I make sure I have said it, my goal is to generate enough dividend income that I can live off in retirement.

      I am on track to meet all my expenses from dividends in 2018.That is after only a decade of saving and investing.

      So if I do worse than any dividend ETF, mutual fund, hedge fund I am fine with that, as long as I reach my goals.

    3. DGI,
      Don't take it personal. It's not because we don't agree that we have to be mean to each other. You know you are transforming what I say (as I would think that it's a good thing to sell when the market is down and that dividend investors are dummies... seriously).
      I hope we will have another chance to discuss another topic. I won't continue on this one either.
      I'm worry you feel that way, I meant no offence.

    4. I meant *sorry you feel that way....

    5. I think it is tough to have a really thorough and good discussion about some topics online. It is tedious to type etc. I do not really like it if I have to type too much in back and forth format. And if I think I am going in circles ( possibly due to medium)

      I also think we talked about this before on your site, so we might be getting repetitive. I cannot find the link to discussion, but I think we are basically repeating what we said before.

      Plus, you promised me discussion over beers, and haven't delivered yet.

      So I am offended deeply.


  12. I'm in the process of building a dividend strategy with index funds. My REIT index fund yields 4.21%. The other three pay in the 2.5% range, which are mostly held in taxable accounts. Sure it will take longer to get the "snowball" effect rolling, but at least with this strategy, I don't have to worry about buying and selling individual securities.

    1. You gotta do what you are comfortable with.

      However, if some other funds do better than your fund picks, make sure you do not abandon your original ideas and chase past performance



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