Comparing Your Portfolio to an Appropriate Benchmark

Comparing Your Portfolio to an Appropriate Benchmark

Why is Benchmarking Important?
Let’s begin by discussing the importance of comparing your portfolio to an index, a process known as benchmarking. It is important to have a yardstick with which to judge your portfolio’s performance. Without knowing whether your portfolio is lagging or beating your intended benchmark, your performance figures lack true meaning.

The difficulty is in knowing which benchmark would be most relevant for you. To determine this, you must understand the various components in your portfolio because you will want to find an index with similar qualities to your own investments. Do you invest solely in fixed income assets, U.S. equities, or foreign equities? Do you overweight to a certain sector, region, market capitalization, or investment style? These are important considerations when searching for an appropriate index. Fortunately, indexes now exist that focus on most areas of the financial market. You can also use a combination of indexes to achieve the most accurate comparison.

The Major U.S. Indexes

The Dow Jones Industrial Average is composed of 30 large-cap companies in the United States. The components are price-weighted, meaning that a stock with a higher price will influence the index’s performance more than a stock with a lower price. This odd calculation method, the lack of diversification, and foreign exposure make the Dow a relatively weak index to use for your comparison.

The Standard & Poor 500 Composite is much larger than the Dow, with 500 components vs. 30, but like the Dow, the index has no exposure to foreign markets or small to mid-cap companies. On the plus side, the S&P is market cap-weighted rather than price-weighted which we believe is a more suitable calculation method.

What an Appropriate Benchmark Might Be
With all this said, you may be wondering if an appropriate benchmark exists. We believe, no matter the pitfalls, a benchmark is still quite important when looking at your account performance. You need to be well-informed about your portfolio’s holdings and aware of the discrepancies between it and the index(es) you are using.

Once you have determined the overall structure of your portfolio, then it is time to find a benchmark. Currently our international exposure is very limited and so we are encouraging our clients to benchmark to a combination of S&P 500 and the Barclays Capital U.S. Aggregate Bond index which most aligns with their portfolio’s percentage breakdown. For those clients with little or no exposure to the bond market, the S&P 500 is still the most appropriate benchmark for our investment management clients currently.

Even within the bond market there are essential differences between the indexes that you should be aware of. Barclays Capital Aggregate Bond, the index mentioned above, tracks intermediate-term bonds, but there are others that track short and long-term debts. Yields and risk can deviate dramatically between time horizons and the type of bond, i.e. whether it is corporate, mortgage-backed, or a Treasury bond. Again, the devil is in the details.

At a time when we did have exposure overseas, we would have also included the MSCI EAFE as a benchmark. The MSCI EAFE (Europe, Australia, Far East) measures the equity performance of the developed markets, excluding the U.S. and Canada. It consists of 22 developed market country indexes in these three regions.

The last index I will mention, although there are hundreds of acceptable ones, is the Russell 2000, which is a cap-weighted index that measures the performance of approximately 2,000 small-cap Companies in the U.S.

Total Return vs. Price Return

Another caveat for those benchmarking to an index is that, unless you are using a “total return” index, only price return is measured. That means dividends are excluded. For example, in 2011, the S&P 500 index depreciated in price, but the total return registered 2% due to dividends. It is important to be consistent and compare to the total return index; otherwise, you risk underestimating the performance of the index and overestimating the relative performance of your own portfolio.


Understanding what you hold in your portfolio and the risk associated with your holdings is key. If you know the percentage breakdown of U.S. stocks to foreign, fixed income to equity, small to mid to large caps, etc., you will be better prepared to select an appropriate benchmark, which will help you understand how your portfolio is doing relative to the market. If you are taking less risk than the overall U.S. market (as measured by the S&P 500), know that you will most likely underperform the S&P 500 in up markets, but your downside risk should be less.

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