Portfolio underperformance is an issue most investors have to face because everyone cannot make it all the time. Even the most successful investors with a long history of success also face periods of portfolio underperformance. So, what are the reasons and how to deal with this situation? Let’s dive deep to find out.
Reasons for portfolio underperformance
Portfolio underperformance refers to a situation where returns from your portfolio are lower than expected or estimated. There are many reasons why your portfolio underperforms. Here are some possible reasons for your portfolio’s underperformance.
1. Unrealistic expectations
Before everything else, unrealistic expectations are the major reason for portfolio underperformance. Investors all across the globe have been committing the same mistake. You need to understand that financial markets don’t work according to how individuals think or want them to behave. They have their own way of behaving. The key is to walk with the market instead of expecting the market to walk with you. Therefore, it is important to set realistic goals and expectations from your portfolio. Consider aspects like your risk tolerance, economical factors, etc. for setting realistic and achievable goals.
2. Insufficient capital
Insufficient capital can also be the reason for portfolio underperformance. As you know, money earns money, and lack of money or capital bars people from making money. Additionally, if you are relying on income from your portfolio, your portfolio is affected. Therefore, it is absolutely imperative to make yourself independent of your portfolio.
3. Overall economic conditions
Overall economic conditions also affect the performance of your portfolio. It is quite obvious that good economic conditions lead to better performance of your portfolio. Conversely, bad economic conditions lead to bad performance of your portfolio. In such circumstances, the best policy is to wait for the economy to get back on trade. Otherwise, selling assets or other activities adversely affects your portfolio instead of doing good.
4. High investment costs
High investment costs are also among the reasons for portfolio underperformance. Investors often ignore these costs because they appear small in percentage. However, these costs accumulate over time and get substantial. Therefore, it is important to analyze all costs associated with your investments. For instance, you can analyze how much you are paying your investment advisor, taxes, etc.
How to deal with portfolio underperformance
Portfolio underperformance in the short term isn’t a cause of concern and it shouldn’t be for you. Price fluctuations are quite natural as prices of financial instruments continue to rise or fall. In fact, price fluctuations are often caused by noise and there is much seriousness about it. However, portfolio underperformance over the long run is a worrying situation and it should be. If you are facing such a situation, here is what you need to do.
1. Choose the right benchmark for comparison
Choosing the right benchmark for performance comparison is the most important factor. Can you compare a portfolio consisting of bonds and stocks with a portfolio consisting of the S&P 500? No, because there is no similarity between these portfolios. You need a similar portfolio for benchmarking and accurately analyzing performance.
2. Analyze the difference in performance
When you choose the right portfolio for benchmarking, you can precisely analyze the difference in performance.
3. Analyze your assets
The next key step to assess why your portfolio is underperforming is to analyze your assets. This is important because this step helps you determine whether a few assets are causing problems or the entire portfolio is underperforming. Additionally, you can also analyze why your assets are underperforming. For example, if stocks of Company A are underperforming, you need to identify why. You can search for why the company is not returning well on your investment. In short, you have to identify root causes to draw conclusions like whether you should hold or replace that asset in your portfolio.
4. Identify your wrong decisions
By looking at all your assets, you can identify your wrong decisions. For instance, if the underperforming asset is because of factors beyond your control, you aren’t at fault. You didn’t make the wrong decision to buy that asset. However, if you made a bad investment decision, you need to identify your mistake and accept responsibility. Always remember that to err is human. All human beings are prone to making mistakes and no one can claim to be perfect. However, accepting responsibility and learning from mistakes is the key to success.
5. Analyze whether your portfolio is diverse enough
Diversification is among the most important factors that determine the performance of your portfolio. Concentration is among the top reasons for portfolio underperformance. Let me explain in the simplest words. Concentration means your portfolio is relying on one or a couple of assets to perform. On the flip side, diversification means your portfolio is relying on a variety of assets to perform. So, which one is better? Obviously, diversification is because more assets cover the underperformance of one or a couple of assets. It isn’t possible that all assets will underperform. Therefore, you need to analyze whether your portfolio is diverse enough or is it concentrated.
A well-balanced portfolio increases the odds of better performance and vice versa. Investing is a very tricky play and choosing the right assets for your portfolio isn’t enough. You have to carefully decide the weight of every asset in your portfolio. Additionally, you also need to determine how different assets will work together for better performance of the entire portfolio. Therefore, finally, you also need to analyze your portfolio for rebalancing.
Portfolio underperformance summary
Portfolio underperformance is a situation investors often have to face. There are many reasons for portfolio underperformance. For example, your portfolio might underperform because of overall economic conditions. It might also underperform because of incurring high investment costs. The key is to determine the reasons for the underperformance and take the necessary steps for change. There are certain steps you need to take to deal with portfolio underperformance. All these steps will help you maximize the odds of better portfolio performance in the future.