You might wonder how your investments add up. How do they compare to other investments? Sure you are adding money to your account and you see your account grow but does that mean the investments themselves are growing effectively?
In the news we often hear about the performance of the “S&P” and the “Dow Jones” as if their performance must be meaningful. The S&P 500 is a stock market index that tracks the performance of 500 leading publicly traded companies in the United States. The Dow Jones Industrial Average, another stock market index, tracks the performance of 30 large, well-established companies trading on U.S. stock exchanges. Because it has broader representation (500 companies to 30), the S&P 500 is considered to be a better indicator of US stock market health. Other indices focus on different asset classes (bonds, real estate) or styles (value vs growth). These benchmarks measure the performance of a specific market segment or investment style. So, yes, the S&P and Dow Jones do have meaning but how their performance relates to the returns in your portfolio does not necessarily equate to headlines.
How Your Investments Relate to the S&P 500
But what about your own investments? Can you expect their returns to correlate with those of the S&P 500? The answer is yes and no. Since the S&P 500 is an index of only stocks from large US companies, just the large-stock portion of your portfolio will closely follow the S&P 500. When I recommend investments to clients it often includes funds that invest in bonds, emerging markets or real estate and other types of investments. For these investments the S&P or Dow Jones would be a poor barramater. It would be comparing apples to oranges. A variety of investments will result in returns that are different from those in one benchmark.
Custom Benchmarks
When I’m analyzing funds, I use a benchmark that is particular to that fund. For instance, for a Real Estate fund I might use the Morningstar US Real Est TR USD and for an emerging markets fund the Morningstar Emerging Markets Index would be more appropriate. However, I rarely hear headlines in the general media about these indices. Sometimes I’ll also create a blend of benchmarks to compare the entire investment portfolio. You may end up comparing your portfolio’s performance to that of several benchmarks depending on the types of investments you hold. Using appropriate benchmarks gives an accurate sense of how an investment is performing. In addition, benchmarks, with their own level of risk, allow you to determine whether your portfolio is taking on more risk than intended. If your Large US Company Index funds have more risk than the S&P 500, it might be prudent to exchange one or more of those index funds for ones with a lower risk.
Long-Term Perspective
What if your portfolio outperforms the benchmark in a given year? After you’re done congratulating yourself, consider the following: if you have a long-term investing strategy, fluctuations from year-to-year matter less than long-term results. I look back five to ten or more years when comparing investments to their benchmarks. Therefore, you might monitor a fund, instead of selling it, if it did not perform as well as its benchmark in any given year as long as it meets other important criteria. Note: Important criteria I consider are fees, number of companies in a portfolio, if the fund is investing in what it purports to invest in, among others. Therefore, there is no need to be hasty about selling if important fundamentals for the fund are in place.
To summarize, be considerate about how you measure investment performance. Don’t let headlines throw you off. Use a benchmark that is appropriate for the investment you hold. In other words, don’t compare apples to oranges. Once you’ve done your comparison, consider what that says about the action that needs to be taken, if any. A long term perspective will serve you well so look at how your investment has been trending and if the underlying investment is still solid.