Friday, April 27, 2012

Benchmarking



I was out walking the other day and was thinking about a friend's recent experience learning about finance.  Learning something new can be frustrating...especially if you aren't very good with numbers.  Trying to explain how to measure a fund performance can get tricky.  One way of measuring performance of a fund is comparing against a standard benchmark used throughout the industry…the S&P 500.


If a fund manager can beat the S&P 500 benchmark then that fund is considered to be doing well (beating the market).  If the fund cannot beat the benchmark…then you would have been better off investing in the index fund of that particular benchmark (if the index truly matches the index performance).
Obviously several benchmarks exist for each type of market.  Bond markets have benchmarks as well.  Benchmarks are important for several reasons.  They can be as a way to psychologically sway yourself out of a bad fund.  I have come across people who will not sell or stop investing in a bad fund for various reasons.  The fund itself isn't what is bad.  Typically it is the fee structure and/or management team.


Past mistakes are known as sunk costs.  What you do in the present and future is what matters.  Holding onto a poor performing fund is typically never a good idea.  Many times these under performing funds have fast talking sales people who guilt you into keeping these funds.  Don’t be ashamed or upset…they are just doing their job.   It happens all the time…it happened to my mother.  Fortunately for her I was able to work with her and convince her that she needed to sell.  Her financial guy in our opinion...was basically robbing her of a great deal of wealth each and every year.

One of the tools that I used to convince her to exit was by showing her the benchmark that the fund was using.  We also looked at the history her account, and where the cash was flowing.  Then I showed her a better way of investing.  If you don’t have a strategy of something else to go into then it will be difficult to switch.  Fortunately my mother had invested in CDs for many years and it was something she was very comfortable with doing.  This an easy intermediate step before you get on a new path of investing.
If a broker ever boasts about their experience level, talks about the tax consequences of leaving, tell you that you aren't the biggest client, and/or if you think you can do better than them...go for it.


Don't know what to do with the money?  Pay off debt, or investing in government bonds by going to Treasury Direct is always a good place to start.

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