When you look at the role of financial markets in broader society, context is key.
For example, if you’re an inner city kid just trying to get a quality education, the relative performance of the Russell 2000 versus the S&P 500 means nothing.
If you’re a Chinese citizen, the performance of a stock listed in the US matters little, if at all, to your daily life.
However, if you consider the large state-run pension funds or higher education foundations that fund teacher and public employee pensions, their portfolio performance are important to the public in my view.
So looking at investment situations within an overall context is important, especially when doing rigorous analysis.
Let’s apply this lesson to individual portfolio management.
Those who cover finance often mention individual sectors or holdings and discuss their performance over a time frame.
In doing so, without giving context about the overall portfolio performance and the weight given to a holding in question, a viewer is receiving incomplete information in my opinion.
Imagine that you have a portfolio of 10 holdings. Now, imagine that one of those stocks, comprising one-tenth of 1% of the total value, drops by 20%–but the overall value of the portfolio goes up 20%.
Does the portfolio owner flip out because one stock was terrible?
In most cases, probably not.
Taking it even further, if a company has a ten-year track record of beating the market indexes by many percentage points, Amazon (AMZN) or Facebook (FB) come to mind, the fact that it dropped 20 percent over a month or two means very little.
Context matters in both life and in finance.
Photo Credit: Dave Lonsdale via Flickr Creative Commons