The word benchmark was originally a surveying term. You put a mark on a bench, next year you come back and you’re able to set up your same angles. The word eventually morphed over time and now represents anything that you want to compare yourself to. When it comes to investing, what most people consider a benchmark is an index.
A whole bunch of them exist, but some common ones are the DOW, the S & P, the S & P 500, the TSX and the NASDAQ. These are all relative indices used to compare performance. If you’re an aggressive growth stock investor and you’ve got a lot of names on the NASDAQ, it would make sense for you to compare your performance to the NASDAQ.
If you’re a Canadian investor, you should look at the TSX total composite returns. You want to know how much you got on the dividend and you want to know how much you received for the growth of the stock. If you’re looking globally, there’s MSCI, the Russell indices, which are the footsies, so FTSE. These are separate indices that exist, and they’re used to measure and analyze the risk and return of your portfolio.
When you’re using a benchmark, you’re saying, okay, I have an asset allocation that is 60 / 40. I have 60% stocks, 40% bonds. With a 60 / 40 portfolio, the benchmark that should be used is a 60 / 40 benchmark. Generally, you could use an all DEX bond index or a universe DEX bond index as a benchmark for your fixed income. You could use either an all cap U.S. equity or perhaps an all global cap equity as a benchmark for your stocks. That’s what most people would do.
If you have some different stuff in your portfolio, maybe some alternatives, maybe a growth portfolio, maybe nothing but mature large cap blue chip stocks… that’s going to be impactful in deciding what you should do.
How to Effectively use Benchmarks
The problem with benchmarking is that you’ve got to make sure it’s representative of what you’re actually doing in your portfolio. And not only that… is it actually helping you? Is it giving you a benefit? I like to think that absolute and risk adjusted returns are truly important. You want to be able to generate returns in markets no matter what happens in the stock market.
For me, I like to think of an absolute return as an important benchmark for clients. Did we make money regardless, and how much of the upside or the downside did we actually get of the market for our clients? An upside capture number would be 80 to 90% of the upside while only getting 30 or 40% of the downside, that would be remarkable risk adjusted returns.
To summarize, you want to outperform the benchmarks and make sure that you’re using them to manage your risk. For most people, it doesn’t make sense for them to be 100% equities or 100% growth equities, most people need to have a little bit of their portfolio to reduce the volatility.
That can be something as bonds, GICs or cash. It could also be stuff like private debt or any alternatives to the stock market. Those do wonders for your risk adjusted return, either private debt or private equity.
If you’re comparing those to a benchmark, you need to make sure that you’re comparing it to an alternative type benchmark. There are a whole bunch that exist. Russell’s got a sleeve of them., MSCI has a bunch of them. The footsie, all of the indices in the US, are quite common. You’ve heard of them, you know them, the Dow, the NASDAQ, the S & P 500. In Canada, the TSX total composite return is one you should be using. Then you just kind of compare what your geographic allocation is, what your total asset allocation is, and you build an actual benchmark from that.