Wealth Building
Adam Horning No Comments

Benchmarking your investments plays an important role in evaluating the performance of your investment portfolio.  If there were only one benchmark to use, and one that could be universally applied, that might be an easy proposition. But the reality is that investment performance is not so simple.

You can prove this for yourself with a quick Google search. Search for investment benchmark and you get over 100 million results. Obviously there are not that many ways to measure the performance of your investments, but still, there are a lot of ways to measure a benchmark.

Understand a better benchmark

Instead of trying to play catchup with an industry benchmark, there is a wiser strategy. A strategy that will allow you to grow and expand your portfolio over time without losing sleep every time you see your portfolio statement.  Especially when the markets are volatile or when your find yourself invested during the next recession.

Ideas From The Diet World

It’s likely that the next time you visit a book store, you’ll barely be in the entryway before noticing the section with the largest selection of books. Yep, it’s weight loss.

Here’s an analogy that illustrates the point about benchmarks. The point to consider is that if there were one diet that worked for everyone and every circumstance, there would not be such a wide selection of diet books on those shelves.

The same concept applies in the world of investing.

Tell Me More…

Now take a look at a typical investment portfolio. Suppose you have a diversified retirement account that you have been funding for several years. What do “they” tell you to look at? Most often, investors are told to compare the performance of their portfolio to that of a major benchmark.  One of the most commonly used benchmark in this case can be the S&P 500.

While the S&P 500 is a commonly used portfolio performance comparison benchmark, how does this work up in the real world? Suppose you run a report  showing that your portfolio outperformed the S&P 500.

Wow! That’s great news, right! But just one second..  What about the next quarter when your report shows you’re your portfolio has lagged the S&P 500?  Now what? Is your portfolio really lagging? Or is there something else going on here?

Real World Benchmarks

The reality is that if the last scenario had happened to you, you might be tempted to react in a negative manner.   What’s happening here is that you are engaged in a comparison game that does not make sense over time. As you have probably noticed by now, the market goes up and the market goes down.  But beyond that, different sectors of the market go up and down at different times.  For example, a well-diversified portfolio may have money invested in a variety of parts of the market including, Large, Medium and Small US based companies, emerging markets, international developed companies, investment grade bonds, high yield bonds, real estate and commodities. The reason you have your money spread out this way is that its impossibly to know which of those parts of the market is going to be the best performer, and  in which year that is going to happen. By having exposure to many parts of the market, you can be more confident that at least a portion of your portfolio will catch those gains when they occur.

Beyond the opportunity for growth, having exposure to different investments can help to limit the downside risk that you take.  Many investments behave differently during different market conditions.  A well designed portfolio will often have stocks, bonds, real estate, commodities and cash, and those holdings are designed to behave differently.  The technical term for this is having a Neutral, or Negative Correlation.  By having this mix of investments, when a part of your account is down, there may be a different part of your account that is up, and having that combination can help reduce the volatility and risk you are taking in your account.  It doesn’t always work. There can be years where all parts of the investment account are down, but having the dollars spread out will help reduce those swings and allow you to get your rest at night.

So what’s the best Benchmark? We recommend working with an adviser, or using a tool that can compare your portfolio, and the amount of risk you are taking, with an appropriate combination of benchmarks that are similar to your portfolio.  For example, if you have 70% of your account in stocks and 30% in bonds, you should likewise have your benchmarks at 70% and 30% respectively.  Beyond that, if you are holding Large Cap, Small Cap, Emerging Markets and other positions within your account, your benchmarks should closely match the mix that you have in your account.  This is call using a Blended Benchmark.   For a realistic picture of your account performance and how your portfolio is doing, consider working with an adviser or using a performance reporting tool that will show you your portfolio returns compare to a similar blended benchmark.