All too often, investors assume that if they're making money, they're doing everything right. In reality, though, just because you see your portfolio's value rise doesn't mean that you're a top investor -- or even above-average.
Investing mixes two very different elements: the personal and the competitive. In one sense, it doesn't matter how well you do compared to your peers. As long as you accumulate enough wealth over the years to meet all your financial goals, then you can declare victory. Conversely, you might get top-notch returns, but if it's not enough to finance your dreams, then it's hard to say that your efforts were completely successful.
Even though your personal situation is a key part of your finances, you can still gain a lot from comparing your results to those of your peers. Especially during markets with extreme swings like the ones we've seen over the past year, keeping your eye on whether you're in step with other investors can help you detect weaknesses that you might otherwise never have noticed.
Using the right benchmark
The easiest way to measure your performance is against an appropriate benchmark, such as a market index. Using benchmarks has two advantages over trying to make direct comparisons with other investors:
- You don't have to find a group of people who are willing to disclose their personal financial results to you.
- It's typically easy to track a benchmark index's performance through an index mutual fund or ETF. If you find yourself consistently underperforming the benchmark, one potential solution would be to shift your money into the index fund.
With every investment, however, it can be tricky to pick the right benchmark. There are many different benchmarks to choose from, and since each will perform differently, you can easily draw the wrong conclusion, depending on which benchmark you measure yourself against.
A winning pick?
For example, say that you did some extensive research on the beaten-down financial sector earlier this year. After scouting several different endangered stock prospects for value, you chose to buy shares of Wells Fargo
From an absolute standpoint, you should be pleased with the results -- Wells Fargo has more than doubled over that time frame. If you use a broad-market benchmark like the S&P 500 for comparison purposes, Wells' 134% return easily outpaces the roughly 42% gain for the index. And even looking at the KBW Bank Index, which is up more than 90% since February, and includes other big banks such as JPMorgan Chase
Yet even so, you still may have made a mistake. If you only looked at Wells and other threatened bank stocks like Bank of America
Apples to apples
Similarly, if you invest in a number of different asset classes, you need to be careful when comparing results of various investments. Take Brazilian stocks, for instance. Looking at the returns of stocks such as Vale
If you want to be a successful investor, you need to know where you stand, not just in relation to your personal financial goals, but also compared to other investors. If you're not picking the best stocks you can, that doesn't necessarily mean you should give up on choosing your own investments. However, you also shouldn't ignore your underperformance. Only by identifying your mistakes can you hope to correct them -- and start earning more from your investments.
If you're in a hurry to get all your money into the stock market, wait a minute and read why Alex Dumortier thinks that cash might be the best investment opportunity of all right now.
Fool contributor Dan Caplinger does well enough with his investing, but could definitely do better. He doesn't own shares of the companies mentioned in this article. Petroleo Brasileiro is a Motley Fool Income Investor selection. Try any of our Foolish newsletter services free for 30 days. The Fool's disclosure policy puts all of our stock picks under those bright fluorescent lights that make everyone look slightly pale.