Investors can use benchmarks to help gauge how their portfolios are performing. Find an appropriate benchmark to compare to your portfolio and keep your investing goals in mind.
By Viraj Desai April 2, 2019 5 min read
5 min read
Photo by Getty Images
Key Takeaways
Benchmarks can provide good comparison tools in measuring your portfolio performance
Choose a benchmark that’s similar to the holdings in your own accounts
Keep your portfolio goals in mind as you measure performance against benchmarks
Many investors turn to market benchmarks to help measure how their assets are doing. Benchmarks provide a standard to gauge the return of either individual securities or an investor’s total portfolio. Investors typically use broader stock indices such as the S&P 500 (SPX), the Dow Jones Industrial Average ($DJI), or the Nasdaq Composite (COMP), but you can measure your portfolio’s performance against a whole range of benchmarks.
Benchmarks are valuable toolsto gauge how your portfolio is performing during market upswings and downturns, and more importantly, how it’s performing against your goals and time line for achieving them. Keep in mind that using benchmarks is not appropriate in all cases, so try not to get obsessed with these measures. Still, there are several ways to use the right benchmark to your advantage.
Using Benchmarks
Benchmarks can provide a good tool to measure how your portfolio is performing, but they shouldn’t be the only gauge you use. They can shed light on how your assets are doing, but placing too much emphasis on measuring performance against other assets can sometimes provide an incomplete picture.
Instead of letting benchmarks alone dictate whether your portfolio is succeeding or failing, keep your investing goals in mind.
If you’ve set long-term portfolio goals with a financial advisor, you can take those into account as you review how your investments are performing. Various goals you might set, such as funding retirement or paying for college, are potentially obtainable and can give you a real target to shoot for.
How to Choose an Appropriate Benchmark
There are several ways to use market benchmarks.Consider selecting a benchmark that’s similar to your own holdings for a better comparison.
Avoid choosing a benchmark that is either too broad or too narrow in focus.For example, if you have a basket of blue-chip stocks or large, established companies, you may want to compare your portfolio against the $DJI, which has many of those holdings. On the other hand, if your stocks are focused specifically on a sector such as technology, you may want to find an index that holds more of those securities, such as the S&P Technology Select Sector Index (IXT). If you have bonds for fixed income, it might make sense to compare them to a bond index such as Bloomberg Barclays Capital U.S. Aggregate Bond Index.
It’s common to use broader indices as benchmarks because their movements are publicized in financial news outlets. But on any given day (or other time period), a particular company or industry may be significantly affecting the movements of a broad index. For investors who don’t have that company in their portfolio, measuring the portfolio’s performance against that broader index might be less effective.
“Investors may find that portfolios diversified across equities and fixed income may lag the S&P 500 in an up market, but outperform the Bloomberg Barclays Aggregate Bond Index, and in a down market, they might experience the opposite,” says Viraj Desai, senior manager of portfolio construction at TDAmeritrade Investment Management, LLC. “Setting return expectations based on your risk tolerance and time horizon helps reconcile how the S&P 500 is doing versus a portfolio.”
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Similarly, investors who focus on a benchmark that’s more narrow than their holdings can also run into problems. For example, if a single asset class is performing well, investors with diversified portfolios may feel their holdings are underperforming. They might adjust their holdings toward that asset class—pursuing the same success as a benchmark at the cost of their portfolio diversity, and perhaps at the cost of their own investment goals.
Investors who hold a good amount of U.S. small-cap stocks can use an index like The Russell 2000 to measure their portfolio’s performance. Or, for those who have diversified their holdings to include global stocks, one commonly used index is Morgan Stanley’s MSCI EAFE Index, which measures international equities across 21 developed markets.
The Bottom Line
Benchmarks can be a valuable way to gauge how your portfolio is doing, but it’s important to find a benchmark that offers a good comparison to your holdings.
As you monitor your portfolio, consider the long-term financial goals you set. Benchmarks may be a good way to determine how your portfolio is performing, because you ideally want the portfolio to perform in a way that meets your needs and risk tolerance.
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By Viraj Desai
Director, Charles Schwab Investment Management
Key Takeaways
Benchmarks can provide good comparison tools in measuring your portfolio performance
Choose a benchmark that’s similar to the holdings in your own accounts
Keep your portfolio goals in mind as you measure performance against benchmarks
What Is a Benchmark in Finance? Financial benchmarking involves running financial analyses in order to compare business practices and the standards of a firm to other firms within the same industry. A benchmark is a standard, or a baseline, that's used for comparative purposes when assessing a portfolio or mutual fund.
Some examples of top fixed income benchmarks include the Bloomberg Aggregate Bond Index (known as the Agg), the Bloomberg Capital U.S. Corporate High Yield Bond Index, and the Bloomberg Capital U.S. Treasury Bond Index.
You can also consult your local Board of Trade or Chamber of Commerce for ratio values specific to your geographical area, or the industry association for ratio values specific to your industry sector.
A benchmark is a standard or measure that can be used to analyze the allocation, risk, and return of a given portfolio. A variety of benchmarks can also be used to understand how a portfolio is performing against various market segments. The S&P 500 index is often used as a benchmark for equities.
In most circ*mstances, the group-level benchmarks are created by calculating the weighted average of a benchmark variable for the members of the group (e.g., males and females).
For example, you can compare the customer satisfaction of a competitor's product to yours. If your competitor is getting better customer reviews, you need to analyze what the difference is and figure out how to improve the quality of your product.
There are four main types of benchmarking: internal, external, performance, and practice. 1. Performance benchmarking involves gathering and comparing quantitative data (i.e., measures or key performance indicators).
Three different types of benchmarking can be defined in this way: process, performance and strategic. Process benchmarking is about comparing the steps in your operation versus the ones that others have mapped out.
For example, the FTSE 100, a well-known benchmark index, encapsulates the performance of the 100 largest companies listed on the London Stock Exchange. The benchmark index serves not just as a reflection of the market's health but also as a yardstick for fund managers and investors alike.
Benchmarking Strategies - There are two main benchmarking strategies that investors can use: passive and active. Passive benchmarking involves investing in an index fund that tracks a market index. Active benchmarking involves selecting investments that outperform the market index.
Higher performance levels of other organisations are normally called benchmarks and the ideal benchmark is one that originates from an organisation recognised as being a leader in the related area.
Generally, a ratio of 1.5 to 2 is ideal, and between 1 and 1.5 is acceptable. A ratio less than one is unfavourable. A positive working capital will ensure the operation can cover short-term debts and operating expenses.
60/40 has delivered a CAGR of 7% with an annualised vol of 10%, providing a respectable (daily, zero risk-free rate) Sharpe Ratio of 0.73. It is clear from the equity curve above that subsequent to the Global Financial Crisis of 2008 the 60/40 portfolio has performed well, even on an inflation-adjusted basis.
The benchmark should reflect the investment objectives, asset class, and geographic focus of the mutual fund. For large-cap funds, the benchmark could be Nifty50, while for small-cap funds, the benchmark could be Nifty Smallcap 100.
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