I like to think that I make perfectly rational decisions and that I always choose the right option - of course I am fooling myself and reality catches up with me pretty quickly, but how do you check if your passive investing strategy has served you well, or - even better - was the best you could have picked?
Well, an easy tool to understand that is Backtest by CURVO. I find it fascinating because it allows to compare the past performance of any portfolio you can conceive and even benchmark yourself against some gurus like Warren Buffet. Keep in mind the usual warning please: past performance is not a predictor of future performance.
All you need to do is go to the website, create your portfolio (they track a lot of ETFs, I have never been disappointed) and then see how you compare with Vanguard FTSE All-World or with Warren Buffet´s portfolio.
Spoiler alert, from 2005 (longest timeframe available) until February 2022, both have kicked my ass. The assumptions are no rebalancing and a dollar cost averaging investing approach (1,000 Euro every month).
Warren Buffet - using his 90% S&P500 and 10% short term USA treasury bonds - has performed better than myself and the Vanguard ETF. He got higher returns and with less volatility - outperforming everyone on the Sharpe ratio as a result. I (re-)learnt it only recently - but basically the Sharpe ratio measures the performance of an asset while considering its risk, so it measures the risk-adjusted return of the asset.
What explains my underperformance vs Warren Buffet and VWCE?
Very simple: North America. This region is the one that has outperformed the others in the timeframe considered and I have the lowest weight in it compared to the other two options considered. You can clearly see this once we break down the different regions and compare them.
Warren Buffet allocation of its stock portfolio is 100% North America based with the S&P 500. The market allocation of VWCE is 60% USA at the time of writing. I have a paultry 33% instead. With these premises, I was bound to have a lower return than both.
Based on this, should I change my strategy?
I am not yet convinced. And I believe I have some good reasons to not to be. In this paper from 2011, the authors show that global diversification in the long term (data considered goes from 1950 to 2008) works better than betting on any single country. And, they also show that an equal weight approach outperforms a market weight one (VWCE follows this approach) because it increases the level of diversification.
PS to be fully transparent the article linked above is more about the fact that international diversification might seem like a letdown during market crashes as all markets crash at the same time. The authors argue that this is missing the big picture: over the long term, the economic performance of a country will drive the performance of its market and therefore diversification protects the investor from being overexposed to a country with poor long term economic growth potential.
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