We are a fiduciary firm!

(818) 887-6443

[email protected]

20335 Ventura Boulevard, Suite 125

Woodland Hills, CA 91364

How to Use Financial Indexes as Investment Benchmarks

Success in life is often times about perspective, and this truth follows suit in the investing realm as well.  The performance of your investments can be deemed good, acceptable or poor, depending upon the performance of the funds around you.  This is where benchmarking plays its role.  Benchmarking provides a common way to assess the performance of the market as a whole, but it can be a great tool to assess the performance of individual investments as well.  But in order to make an accurate assessment, you have to use these indexes correctly.

Media outlets around the world use the value of popular indexes to illustrate the movement in the market.  We have all seen the digits from the S&P 500, the Nasdaq, or the Dow Jones Industrial Average slowly slide across the bottom of our screen or scroll behind the newscaster sitting in the studio.  To most people, those numbers look something like the overcrowded chalkboard next to Einstein in one of his famous photos.  To investors, they serve as a guideline of the general market and also as a benchmark for those who have set their goal at exceeding that performance.  But the truth is, by using those as a benchmark, they have set themselves up for a losing battle.

The problem with this strict comparison lies in the costs incurred by the investors and not by the values broadcasted from those indexes.  There are costs and fees accrued from actions such as trading, commissions, loads, management fees, account fees and taxes that are not accounted for in those major indexes.  These costs are present whether stocks are simply held or if they are moved to, from, or within a fund or portfolio.  Essentially, using these indexes as strict benchmarks is like comparing apples to oranges.  They simply don’t face the same conditions.

This isn’t to say that benchmarking is bad, but like mentioned before, it needs to be done correctly.  These indexes can provide a valuable guide or overview of the assets it encompasses, giving a simple picture to what would be a nearly incomprehensible array of data.  So the question is, how do you assess your performance and what do you use as a benchmark?

The answer to the first is likely right under your nose, hidden between the lines in your mutual funds.  That text that explains your fund contains information on accurate performance results.  Watch these for specific figures that show a net of your management fees and expenses.  Your fund’s actual performance can be configured from this.

In terms of finding a benchmark, this is dependent upon your actual holdings.  You want to find a benchmark that matches your investments as close as possible in terms of the style and cost, effectively comparing apples to apples and oranges to oranges.  As your investments and portfolios change shape and you make changes, evolve your benchmarks into a form that will match.  It’s wise to find a couple of indexes, two at a minimum, to use to track your performance.

There are a few popular indexes that are commonly adapted to fit the benchmarking needs of most investors depending on their investment behaviors:

  • For those with mutual funds, the Lipper Indexes are a good choice.  The series of indexes are grouped according to category, listing the largest 30 mutual funds matching the criteria needed by the investor.
  • Sector SPDRs, also known as spiders, are a popular choice for both individual investors and those with mutual funds, as they use themed ETFs (Exchange Traded Funds)  to track particular sectors and their overall performance.
  • Bondholders often rely on the simple benchmark of inflation.  Most holders aim to simply hold their principal amount and keep pace with the inflation, which can serve as a valuable yardstick.

Overall, it’s important not to get too terribly wrapped up in your performance above or below a benchmark.  They provide a good guide, but your investment sun doesn’t set and rise on their say.  They can be used to assess your costs, plan for your future, or simply confirm or deny what you expect to be a quality performance.  As we said before, success is about perspective, and giving yourself that proper perspective gives you a much better chance at success.

Services are provided in surrounding cities including...