How to Use Benchmarks to Measure Portfolio Performance

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 tools to 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 TD Ameritrade 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.”

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.