Comparison theory was first put forth in 1954 by psychologist Leon Gestinger, who hypothesized that we make comparisons as a way of evaluating ourselves – especially in social settings. At its root, it is connected to the brain’s network that is traced back to protect oneself against threats. (1)
In today’s world, specifically social media, the continuous 24/7 TV and internet media have been designed to trigger this built-in human condition in an effort to boost mostly advertising revenue.
Computer algorithms are used in several ways. They are used to boost how wonderful someone appears to be based on “likes,” to the stories and words TV anchors use to sensationalize the euphoria of market highs and impending doom of market declines. They all are designed to elicit an emotional response. A comparison. This sells.
What is missing is normally the complete story and the data – the drivers behind each event. This is very pronounced in speaking about “The Market.”
“The Market?” What is “The Market?” A hundred years or so ago, when wide spread capitalism was relatively concentrated, it was easier to narrow this phrase. It normally meant the DOW Jones Industrial.
As economies grew, were born, matured, and were replaced, “The Market” is now ambiguous and diverse. The market could mean the Stock Market, but that can be broken down into a collection of Large Capital companies, Medium Capitalized companies, Smaller companies, International companies, all companies that are traded, emerging market (does China count as an emerging country – the second largest economy in the world, I’d contend they have arrived but they are include in the “Emerging Market”), European companies . . . on to the “Bond Market” . . . are we talking about corporate bonds, government bonds . . . I think you get the picture. “The Market” is wide and undefined.
To make matters even worse, within each “Market” one must understand the components – how it is made up. This is key data that sheds light if using it as a comparison is meaningful. To illustrate this point, we will use the S&P 500 as an example.
The S&P 500 Index is a collection of 500 US stocks that are weighted in the index based on market capitalization, which is calculated by the number of outstanding shares issued multiple by the stock price. The larger the company, the larger the percentage in the index. I hope you can see the inherent danger in this approach.
If you have a situation where a handful of large company stocks are so large, they over power all the rest. This is the exact situation in the S&P 500. There are approximately 25 companies or so (about 5% of the total number) that drive the return. The rest don’t really matter.
Below is a heat map that shows, by sector, the components of the S&P 500, where the size of each box represents market cap. (2)
This illustrates the market capitalization impact (the larger the box, the larger the company’s impact.) discussed above and gives a pretext to dangers inherent in comparing your portfolio to “The Market.” Here are some stats: (3)
FAANG (Facebook, Amazon, Apple Netflix and (Google/Alphabet) + Microsoft account for more market cap (or impact) than the bottom 270+ companies, combined;
Apple alone accounts for ~3.9% of the index, more than the bottom 100+ companies combined;
The top 30 companies account for more than 40% of the index and;
The weighted market average market cap of the S&P 500 is ~ $270 billion, but only 17 (<3.5%) of the 500 companies in the index have a market cap greater than that!
So comparing you to “The S&P” as the “Market is essentially narrowed to a handful of companies and becomes inherently dangerous. Additionally, using price appreciation as a sole measure drives dependency to one common thought – “The Market” must always go up. Sometimes it takes a pause!
Additionally, most people do not have just one investment, even if it is a vehicle that tracks S&P 500. So why do people do this? Because we hear it every day, we are conditioned to do so, and it becomes a habit.
For our client’s portfolio, we use customized benchmarks, which more closely align how they are invested. We also use other metrics to ensure we are on track to meet their spending goals. Some of them are the cashflow increase rate – the year over year increase in income and Yield on Cost – the percentage gained by current income generated divided by the initial investment.
When you hear “The Market,” dive deeper into the data and see if a comparison is applicable to your situation. Are their other more meaningful metrics to consider.
If you are a client and have questions on specifics from the general discussion above, call and we will explain in detail.
If you are not a client and would like help with your situation, give us a call.
Sources & Disclosures
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results.
All indices are unmanaged and may not be invested into directly. The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
All investing involves risk including loss of principal. No strategy, including rebalancing and diversification, assures success or protects against loss.
Companies mentioned are for informational purposes only, and not a recommendation or solicitation to transact any company security.
The payment of dividends is not guaranteed. Companies may reduce or eliminate the payment of dividends at any given time.
Past performance is not necessarily a reliable indicator for current and future performance.
1 Psychology Today – The Comparison Trap Nov 7, 2017.
2.Finviz.com as of 8-16-2018
3.Factset as presented by