I was recently going over some of Benjamin Graham’s old lectures at Columbia University when I came upon one gem of wisdom that I wanted to share with you. In my paraphrase, Graham said this: Achieving satisfactory results with stock market investing is much easier than people think. Beating the S&P 500 on a reliable basis is much harder than people think.
The funny thing about investing is that we will never know how we did because it is a lifelong pursuit. Sure, if you have been investing for twenty years you can get an idea of how you have performed in relation to the S&P 500 index overall, but that tells you little about how you will be doing going forward. After all, if you have beaten the S&P 500 for the past twenty years, there is no guarantee that you will continue to do so over the next twenty. And if you trailed the S&P 500 for the past twenty years, it is possible that you may have learned from your mistakes and will perform better over the next twenty.
The logic behind comparing yourself to the S&P 500 is that it may be irrational to spend your life picking stocks if you would be better off visiting vanguard.com, opening up a brokerage account, and socking down $3,000 to buy an index fund with negligible fees. What is foolish, though, is thinking that you are some kind of failure if you do not happen to beat the index over a given period of time.
Imagine if you trained to run a marathon every day with one of your friends. Sure, there is going to be a friendly competition between the two of you, and you would like to beat him when the big day to knock out the 26.2 miles arrives. But if he runs a marathon in 3 hours and 52 minutes and you run it in 4 hours, it’s completely asinine to feel bad about your performance. Over the course of your training, you got in ridiculous shape. You were able to complete a marathon, which is something that very few Americans boast.
With investing, all that matter is whether you can reach your goals or not. If you dream is to rake in $120,000 per year so you can chill with your wife on the beach all day after your kids strike out on their own, you’re set if you are able to safely generate $120,000 each year so you can live out your dreams. If you reach the point where you’re bringing in $120,000+ each year, who cares if you beat the S&P 500 index or not? It’s all about whether you have the financial resources necessary to live the kind of life you desire.
The truth is, I have no idea whether I will be able to beat the S&P 500 Index over the course of my lifetime. But who cares? I am able to craft a strategy that allows me to increase my purchasing power by a satisfactory rate over long periods of time, and it is my job to delay gratification in such a way that I can still reach my goals even if I do not achieve the growth I expect.
Let me explain. When we are dealing with the top quality companies in the world (think Coca-Cola, Colgate-Palmolive, ExxonMobil, Chevron, PepsiCo, Johnson & Johnson, Procter & Gamble, etc.), I am investing with the expectation that those companies will generate compound growth somewhere between 8% and 12%. If history is any guide, it should err on the 10-12% side of the range (after all, if I did not think these were the best companies in the world, I wouldn’t waste my time contemplating owning them for 30+ years).
But here is the thing: if I am doing my job right, I should be able to get to where I need to go even if I only compound my portfolio (in aggregate) at an 8% rate. All of my savings goals projections hinge on 8% returns, and if I do better than that, it’s just blue icing on the chocolate cake.
Maybe the indexes will do better than that. Maybe they’ll do worse. Maybe I’ll do better. Maybe I’ll do worse. Who knows? Your performance against the S&P 500 isn’t final until you are dead/no longer investing, and that’s not what investing is about anyway. Money is just a tool that you can use to buy cool experiences and material goods. Determine the cost of your ideal lifestyle, and then figure out a savings rate you need to achieve to make it happen. Beating the S&P 500 over long periods of time may be difficult. But achieving 8% returns from a basket of stocks that include Coke, Colgate, Exxon, Johnson & Johnson, and Procter & Gamble is a no-brainer.
Originally posted 2013-06-30 07:17:17.