Investing Specialists

Finding the Best Benchmark for Your Portfolio

Karen Wallace, CFP®

Benchmarking an individual security is simple enough--fund performance can be compared with an index or category/peer group, for example, and stocks might be compared with others in the same sector or industry. But what is the most relevant comparable for a portfolio as a whole?

In a recent video report, Morningstar ETFInvestor editor Ben Johnson discussed some ideas for benchmarking a portfolio, including creating a customized benchmark that reflects an investor's personal circumstances. For instance, asset allocation, fund-selection decisions, and maybe also some element of the cost of advice or human capital could all be components of one's personal benchmark.

We recently asked our readers how they benchmark their portfolios. Some respondents noted that they use well-known indexes such as the S&P 500 or the Barclays U.S. Aggregate Bond Index as a benchmark. Others said they preferred to use an age-appropriate target-date fund, or a customized blend of mutual funds as a benchmark. 

Many readers, however, were critical of the idea of using a benchmark. Some in this camp said they believe that benchmarking against a traditional market index encourages short-term thinking and possibly even too much trading. Others, meanwhile--particularly those already in retirement--said that they didn't feel they needed a benchmark, as the main consideration for them was having sufficient income. 

Below is a summary of the responses. To read the entire discussion and weigh in yourself, please click here

'Benchmarks do me no good.'
A fair number of respondents to our poll eschewed the idea of using a market index as a benchmark, and some even said they don't use any sort of benchmark at all. Some in this camp felt that comparing a portfolio to a traditional benchmark is arbitrary and doesn't take into consideration their own expectations or long-term needs, such as income replacement.

"'Outperforming' some index that's down 10% on the year by losing 8% is just losing 8%," said capecod. "Why adopt an industry practice designed to fool you in order to fool yourself?!"

"Rather than benchmarks, I rely on an ongoing net-worth analysis measured against only my own expectations and long-term needs," said lionsgate. "Traditional benchmarks are moving targets and easily manipulated to represent any rolling one-, three-, or five-year period. That's why mutual fund companies love to use them in advertising."

Dan6912's take on the subject is that for those in retirement or soon to be retired, it's all about income and paycheck replacement. "Is my pile of stuff throwing off more income this quarter than it did last quarter? If it is, I am winning! If it's not, why not? It's all about the income. I am competing against my own best performance."

Hershey agrees with Dan6912. "We own no bonds or mutual funds. We are invested in quality companies with strong competitive advantages that consistently raise dividends every year (with a few exceptions). We live off the dividends, so we do not have to sell in order to create income. Our goal is to stay ahead of inflation. So far the strategy has worked quite well," Hershey said.

"Since I'm 100% indexed-based, I don't 'benchmark' my diversified portfolios against market metrics," notes farhorizons, who adds: "Benchmarking in a traditional sense just seems like it introduces doubt and encourages trading, usually at exactly the wrong times (moving from 'losers' to 'winners')."

Similarly, retiredgary doesn't pay attention to indexes. "We hope we've positioned our equity investments for the long haul and judge each holding by that criterion, rather than what something else is doing this year. In the fixed-income part of the portfolio, under present conditions, we focus on safety rather than trying to get a slightly less lousy return by matching or beating one of the various bond indexes."

"I care about both income and outgo, and the relationship between the two. Therefore, my 'benchmark' is my bank balance on Dec. 31 of the prior year," said cliff. "If my current bank balance is greater than that, that's a success."

'I have been measuring against the S&P 500 for over 20 years.'
Meanwhile, some other readers--such as Banker5358, quoted above--said that they prefer to look at their portfolios' results relative to a well-known benchmark.

"Since most of my stocks/mutual funds tend to be large cap, I keep it simple and compare results to the S&P 500 Index. For my bond funds, I use a total bond market index," said yogiman.

"I compare my portfolio to the S&P 500," said Chief K. "Then I make allowances for the fact [that] my portfolio ... includes bonds."

"I start with comparison of performance against a simple, unambiguous benchmark," said DetroitRick. "I create that benchmark by weighting the relative market averages in proportion to my own asset allocation. Specifically, I use five indexes to build the benchmark: the S&P 500, Russell 2000, MSCI AW ex US, BarCap Agg, and Morningstar Long Commodity. While I look at this constructed benchmark for various periods, I tend to concentrate on three-year metrics for making performance-related changes."

"As my portfolio is nearly all equities, I use the Wishire 5000," said hoodee. "It's more all-inclusive than other popular benchmarks and better reflects global investment."

'I use several target-date funds and the Morningstar Target-Date Index as my benchmarks.'
Finally, some readers use target-date funds, or another fund or combination of funds, to measure their portfolios' performance. Bgstuhan, quoted above, further notes: "I figure that if I'm not able to keep pace with target-date funds, I ought to just put all of my money into these funds rather than self-allocating." 

"Because, as a retiree, I think that a 60%/40% equity/bond allocation is about right for me long term, I'm trying to match or exceed the total return of  Vanguard Wellington (VWELX)," said Bacholyte. "If I can't do it, then I might as well buy a lot more of it and spend more time relaxing."

"I use three equal-weighted target-date funds as the benchmark:  Vanguard Target Retirement 2010 VTENX,  T. Rowe Price Retirement 2010 (TRRAX), and  Fidelity Freedom 2010 (FFFCX)," said Jenny.

Similarly, Gatorbyter notes that a combination of target-date funds serve as "decent benchmarks to measure my performance against and include a reasonable allocation of foreign investments." These include  Vanguard Target Retirement 2015 (VTXVX) Fidelity Freedom 2015 (FFVFX), and  T. Rowe Price Retirement 2015 (TRRGX).

Bnorthrop uses  Vanguard LifeStrategy Growth (VASGX) as a benchmark because it is "an aggressive, cheap, passively indexed, and grossly matched portfolio to my own (75%/25%)--similar and dissimilar enough to provide some arm's-length feedback to how I am doing versus more conventional fare."

"I have a well-diversified portfolio with 45% equity, and I consider myself a conservative investor. As I like to have something to compare volatility and performance of my portfolio, I have selected four conservative and/or eclectic funds which don't exactly match my investment vehicles but are conservative:  Vanguard Wellesley Income (VWIAX) Berwyn Income (BERIX), James Balanced: Golden Rainbow (GLRIX), and  Principal Global Diversified Income (PGDIX)," said PaulR888.

Tbonds67 said: "I use the S&P 500 Index via  Vanguard 500 Index (VFIAX). I chose this because it 1) represents "the market" on a total-return basis, and 2) it's tradable--meaning I can access it as an investment vehicle."

Finally, a commonsense perspective was offered by Juris2, who notes that maximizing total return is not a goal, but rather hopes that the portfolio as a whole is growing at a rate that exceeds the RMD or the safe withdrawal amount for the current year. "In my main retirement fund, I benchmark my equity holdings (mutual funds) against the S&P 500 ( Vanguard Institutional Index (VINIX) or  Vanguard S&P 500 ETF (VOO)), and I hope that my combination of large-cap, small-cap, real estate, and international funds beats that benchmark. I also check whether my equity investments beat the  Vanguard Total Stock Market Index ((VTSMX) or (VTI)). Ideally, I am beating both benchmarks. I benchmark the rest of my portfolio--which includes fixed-income, multiasset, and stable-value funds--against  Vanguard Total Bond Market Index (VBMFX)."

 

Karen Wallace, CFP® does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.