Another example as to why S&P 500 might not be the perfect black box to compare your results to is the fact that they didn’t include Berkshire Hathaway (BRK.A, BRK.B) until 2010. Berkshire had been one of the largest U.S. companies for at least 20 years prior to that, which shows you the futility of this index.
In addition, did you know that the original members of S&P 500 and their descendant companies selected in 1957 have actually outperformed the “actively managed” S&P 500 over the past 56 years? This means that truly passive buy and hold investing of the major companies without any rebalancing works better than S&P 500 itself.
If I consistently underperform over a period of 4 – 5 years, I would not worry too much, as long as I followed my common sense guidelines to constructing my portfolios. Focusing too much on comparative performance versus the S&P 500 could lead to chasing performance, which is not very smart.
After all, a group of sound enterprises that are humming along will likely get ignored by the market at least several times over the next 30 – 40 years in favor of hot growth stocks. This has happened in the late 1960s with the go-go tronics boom, early 1970s with the Nifty-Fifty, early 1980s with technology stocks and the late 1990s with tech media and telecom stocks. An investor who underperformed a benchmark that included hot new issues, would face the psychological pressure that they are missing out. If they sell their portfolio to buy that index, they are essentially shooting themselves in the foot because none of the booms described above turned out well for the frenzied investors. They would have been better off sticking to tried and true dividend growth stocks like Procter & Gamble for example.
After a hot growth stock frenzy, sooner or later there will be reversion to the mean, which would translate into losses. In other words, one should stick to their strategy, know why they are following that strategy and ignore chasing performance. Chasing performance is counterproductive to your wealth. While you will underperform over short periods of time, over the long term, your dividend investment strategy would pay dividends.
One reason why mutual fund managers underperform is because they have the constant pressure to show results all the time. As a dividend investor, I do not have that pressure and I can afford to sit out periods where dividend stocks are out of style. I actually feel much more comfortable buying quality dividend stocks when no one believes in them than when everyone starts bidding up these fine companies. For example, back in November 2012 I was able to pick up some shares in McDonald’s (MCD) at $85 when there was short-term weakness in the stock.
The main reason why I purchase dividend stocks is to generate a rising stream of distributions that grows above the level of inflation and pays for my expenses. I do quite a lot of work in terms of stock selection, valuation at purchase price, portfolio monitoring in order to ensure that I can achieve this goal. This is why underperforming the S&P 500 over a short period of time does not bother me. This is because there will be fluctuations in performance depending on which sector is hot in the markets. However, the appeal of dividend investing is that your dividend return is always positive and it is more stable, which makes it ideal for someone who wants to live off their nest egg.