A lot of focus is always placed on the returns an investor achieves against a benchmark such as the S&P/ASX 200 (INDEX: ^AXJO) (ASX: XJO); on the whole this is a good thing for a number of reasons.
Firstly, the market index has historically provided an adequate return for long-term investors.
Secondly, the index has proven to be a tough competitor with long-term outperformance difficult to achieve even by full-time, professional investors.
Thirdly, having a standard benchmark for comparison and measurement against is a good thing.
Despite these positives there are negatives to this approach. Perhaps the biggest negative is that it can provide an excuse for an investor to not achieve a reasonable absolute return.
Take for example the return from the S&P/ASX 200 index over the past year – a gain of less than 1%. The calculation of the index requires weighting to be given by market capitalisation. As a result, the returns from large stocks such as Commonwealth Bank of Australia (ASX: CBA) have a massive influence on the index. In fact, just a handful of stocks ultimately determine the direction of the index, this is despite there being 200 constituents!
So, rather than comparing returns to the overall index, for individual investors it is perhaps more prudent to compare returns against an opportunity set – for example how did you go at selecting the best performing stocks from within the S&P/ASX 200?
On this measure it doesn't matter that the index is basically flat over the last year – you could have averaged returns of over 50% if you had picked a handful of the best performing stocks within the index.
Here are five of the top ten performers:
- Liquefied Natural Gas Ltd (ASX: LNG) up 792.5%
- Alumina Limited (ASX: AWC) up 67.3%
- Ardent Leisure Group (ASX: AAD) up 73.2%
- Caltex Australia Limited (ASX: CTX) up 62%
- Northern Star Resources Ltd (ASX: NST) up 59.5%
Stock Picking Matters!
If you are an individual investor you have the advantage that you can pick the stocks with the very best potential – you don't have to own the index and you don't have to own stocks that will act as a drag on your absolute performance! This freedom of choice can help you achieve returns with little correlation to the overall index.
