By definition, financial benchmarks provide a point of reference – a means of determining how an investment or account is doing versus other similar options. The first rule in benchmark monitoring is to be sure you have an “apples to apples” comparison. In other words, don’t compare a stock market performance against a bond market performance.
Because we use asset allocations in creating a portfolio, we tend to check these against what are called “blended benchmarks.” For example, if a client holds a portfolio that is invested 50% in US stocks and 50% in US bonds, suitable benchmarking might be against the general stock market performance and the general bond market performance.
Literally thousands of benchmarks are available to us. If an investor is heavily into international bonds, a benchmark is available. If invested in European stocks, a benchmark is also readily at hand. The idea is to find the appropriate benchmarks for each holding in one’s portfolio – a blend of benchmarks to help evaluate overall performance.
Most clients tend to use general indexes to assess how their portfolios are performing. For instance, if a client has several different investments in international stocks, an obvious and reasonable benchmark would be the international stock index. The performance of the client’s portfolio would likely depend on the allocation (percentages) they have invested in the various stocks.
It’s important to maintain the same benchmarks over time – not choosing new ones every year – to allow us to see how clients are doing relative to their goals. Let’s say we know that, to meet the goals, we need to have a return of X percent over inflation, and we have set up a macro allocation of stocks, bonds and cash to achieve these goals. Our benchmark should match that macro allocation.
As an investment advisor, however, I am looking at the underlying holdings to be sure they are meeting their targeted returns. My goal is to adjust the investments and allocations so that the overall portfolio meets or exceeds the right macro benchmark.