The Error-Proof Portfolio: Your Investment Performance and the Silver Medal Trap

Mind your own business (MYOB) and creating a custom benchmark are essential to gauging your true success. At least that was the conclusion of a 1995 academic paper by Victoria Husted Medvec, Scott Madey and Thomas Gilovich, which was the subject of a recent report on NPR.

The study’s authors examined the facial expressions of the Olympic medal winners on the podium during the 1992 competition in Barcelona. Even after controlling other factors, their hypothesis held up: The bronze medal winners seemed more content with their prizes than those who took home the silver.

The researchers chalked up these findings to a phenomenon that social scientists call framing – the tendency to respond to events based on our own experiences and cultures. The silver medal winners framed their performance relative to the gold medal winners and berated themselves for not being able to emerge victorious.

The bronze-medal winners, mean- while, did not judge their success alongside the gold and silver winners but relative to the many athletes who left the games without winning any medals at all.
The concept of framing has been an important one in the realm of money and finance as well. In one famous study by Amos Tversky and Daniel Kahneman, shoppers said they would drive 20 minutes to save US$5 on a US$15 calculator but would not drive the same distance to save US$5 on a US$125 calculator. The savings were the same in both instances, the frames were not.

The Olympics study, meanwhile, has particularly rich implications on how investors view their own perfor- mance. By framing our success or failure relative to the wrong yardstick, we risk not only making ourselves miserable but undermining our financial well-being at the same time. Here are some ways to ensure that you are using the right frame of reference when evaluating how you are doing.

MYOB
The obvious takeaway from the Olympics study is one we probably all got from our parents at an early age: mind your own business (MYOB). Just as mentally healthy athletes know that the real gauge of success is how well they have delivered on their own expectations for themselves, the true measure of your investing performance is whether you are getting closer to your goals as the years go by and not whether you are beating Warren Buffett or your boastful brother-in-law.

Yet it is easy to see how so many investors fall into the silver medal trap: They start buying stocks and funds without stopping to think what will constitute personal success or attempting to quantify what they will actually need for financial goals such as retirement.

Online tools such as T Rowe Price’s Retirement Income Calculator and Morningstar’s Asset Allocator can provide a rough gauge of whether your current investments and asset allocation, combined with your planned future contributions, put you on track to reach your goals on an inflation-adjusted basis.
Revisiting your progress towards your goal should be the linchpin of any portfolio check up.

Be Honest About Your Abilities

Even though your progress towards your financial goals should be the main measure of how well you are doing, that does not mean you should not keep track of how good your investment choices have been.

Are you adding value relative to an inexpensive, plain-vanilla benchmark or subtracting it?

To find out, I advise creating a custom benchmark that matches your own portfolio’s asset allocation, saving it in our Portfolio Manager tool and using it to gauge your investment-selection acumen on an ongoing basis.

If your stocks and funds underper- form a benchmark consisting of simple, inexpensive index funds over time, it is wise to ask yourself whether you might not be better off investing in such a cheap, low-maintenance index fund or exchange-traded fund portfolio instead.

Do Not Get Hung Up on the Best

Finally, too many investors like the dour-looking silver medal-winning Olympians have an unhealthy preoccupation with the best. They want to buy the best stocks at the lowest possible prices and they want their funds to be at the top of the heap at any given point in time.

That is a misplaced effort and one that will almost certainly lead to misery and too much trading. Rather than obsessing over obtaining the lowest possible price for a stock or engaging in the impossible task of finding a fund that will always be on top, your best bet is to stack the deck in your favour by keeping your asset allocation sensible and practising smart portfolio-management techniques like dollar-cost averaging and rebalancing.