Define "Tracking Error"

[Fred]

I have been hearing this in regards to the PP that it has a "tracking error". I understand this to mean that it doesn't follow the behavior of a known benchmark, like an Index Fund.

I get that, but why is this considered an "error"?

[Libertarian666]

It isn't really accurate to say that PP has a tracking error, as it is not intended to follow the behavior of a known benchmark.

That is shorthand for "when gold isn't helping the returns, the PP often does much worse than 100% stocks (or whatever mental benchmark the person is referring to)".

These complaints magically disappear when gold is going up and stocks and/or bonds are going down.

[Fred]

It isn't really accurate to say that PP has a tracking error, as it is not intended to follow the behavior of a known benchmark.

That is shorthand for "when gold isn't helping the returns, the PP often does much worse than 100% stocks (or whatever mental benchmark the person is referring to)".

These complaints magically disappear when gold is going up and stocks and/or bonds are going down.

That was one of the reasons Melveyr gave for quitting the PP and I've heard others use the same term so I was curious as to what it really means.

[ochotona]

I think what Mel meant at the time was the PP doesn't track the broader market indices. People use "tracking error" in different contexts, it can be confusing. An investment portfolio can fail to track it's own relevant indices, I think that's the real tracking error. Why apply an irrelevant index and call a mis-track an error? It's not an error, it's a different thing.

The funny thing is, if you found a miracle investment that returns 11% every year, like clockwork, 0% chance of failure, I guarantee you people could not stick with that either. Because some years it would be earning less than the SP500, and other years more. You could say there was a "tracking error". People would seize on that mis-tracking when the SP500 is doing better and would flee the miracle investment. Then they would rush out of the SP500 during bear markets, selling at the bottom, and buy into the miracle investment.

[barrett]

With the Permanent Portfolio we are only trying to track the performance of the S&P 500 (or total stock market), long treasuries, gold & cash. Over time we will fail to do so by a small amount due to the markup in gold, transaction expenses on treasuries, and expense ratios on stock funds. We may fail by a larger margin if we deliberately let an asset get substantially out of balance, but that is a personal decision.

The kind of "tracking error" that melveyr is talking about seems to be the feeling that the PP is not keeping up with more tradition approaches in times of prosperity. It's psychologically difficult to stick with the PP in a year like 2013 when stocks are kicking ass and the PP shows a 2% loss for the year. It's probably even harder to do so if one works in finance or is just generally surrounded by people who boast about the performance of their portfolios. I basically live in a cave and have poor to middle-class friends so I don't have those problems... at least not to the same degree.

This gets back to what a lot of folks seem to be advocating on here lately... that the best portfolio is probably one that a person can stick with over time

[MachineGhost]

I get that, but why is this considered an "error"?

Because you lose your job when it gets too extreme!

[MachineGhost]

That was one of the reasons Melveyr gave for quitting the PP and I've heard others use the same term so I was curious as to what it really means.

In fairness, melveyr is very young.  He's still caught up in the biological envy bias, so not doing as good as everyone else and their mother is painful as being a social pariah.  No one likes feeling left out or being a loser.  But those of us that are older realize we can control and decide what we use as a referrant in our minds.  It's an eternal struggle of vigilance.