Disclosure: This article is written for entertainment purposes only and should not be construed as financial or any other type of professional advice.
“How am I doing?” is a question I often ask myself. I may check the mirror to make sure I’ve applied my sunscreen evenly before heading outside. I may evaluate how I feel on a long run to determine whether I need more water. In regard to my finances, I might check my spending or see how my investments are faring.
In the realm of portfolio management, there are many ways to measure an investment portfolio. Right now, I’ll look at how to gauge portfolio performance compared to its benchmarks. Here are some steps to consider:
Choose the Portfolio or Account to Be Measured
First, I’ll need to decide whether I’m going to look at one investment account, a collection of accounts, or an entire investment portfolio. For example, will I measure the performance of
- one account, such as a 401(k) account?
- a collection of accounts, such as retirement accounts that include a 401(k), IRA, Roth 401(k), Rollover IRAs, etc. ?
- an entire investment portfolio that consists of retirement accounts, college-savings accounts, and investment accounts?
It makes sense to look at an entire portfolio in many cases. But if I want to review how I’m doing when managing my own investments vs. a managed portfolio vs. an investment advisory service, then segmenting various portfolios could work well.
Consider the Asset Allocation
Next, I’d want to consider the asset allocation of the portfolio. Investments could be categorized into asset classes (stocks, bonds) or sub-classes (large-cap stocks, mid-cap stocks, etc.) like these:
- Large-Cap US stocks
- Small-Cap US stocks
- International stocks – developed countries
- International stocks – emerging countries
- US bonds
- International bonds
- Real Estate
- Cash
For each asset class or sub-class, there is an associated percentage of assets. For example, the asset allocation of a retirement portfolio could be 65% large-cap US stocks; 25% international stocks; 5% US bonds; and 5% cash. Though this may or may not be an ideal or model asset allocation, these percentages represent how the portfolio is invested. I’ll use this weighting for my comparison of actual vs. benchmark performance.
Identify Benchmarks
I’ll need to identify appropriate benchmarks to compare the performance of my portfolio with the expected performance. The main idea is to match my groupings of investments to an appropriate index.
The S&P 500 comes to mind as I often read comparisons of a stock’s performance to this benchmark. But it’s unfair to compare the performance of cash and bonds (which are meant to add a layer of safety and income to a portfolio) to that of stocks (which are meant to fuel the growth of a portfolio).
So, it makes sense to find benchmarks or indexes aligned with various asset classes or sub-classes. For example, I’d match large-company stocks in the United States to the S&P 500 while U.S. bonds could be matched with the Bloomberg Barclays US Aggregate Bond Index.
There are loads of indexes from which to choose. Here are benchmarks (market indexes) to consider:
- Large-Cap US stocks: S&P 500
- Small-Cap US stocks: S&P SmallCap 600 or MSCI USA Small Cap
- International stocks – developed countries: S&P Developed Ex-U.S. BMI or MSCI World
- International stocks – emerging countries: MSCI Emerging Markets
- US bonds: Bloomberg Barclays US Aggregate Bond Index
- International bonds: Bloomberg Barclays Global Aggregate Bond Index
- Real Estate: S&P United States REIT or S&P Global REIT
- Cash
Check out S&P Dow Jones Indices, Bloomberg Indices, and MSCI to learn more about indexes available for comparison.
Calculate Actual vs. Benchmark Portfolio Performance
Now I’ll calculate the performance of my portfolio and that of its benchmarks. Let’s say I’m looking at my retirement portfolio and, to keep things simple, I’ll pretend that I didn’t make any contributions or take any distributions in a particular year.
For this illustration, my hypothetical portfolio comprised of individual stocks and bonds has grown from $600,000 to a bit more than $660,000. That’s a 10% investment growth or return. Here’s how that may have happened to my portfolio:
- U.S. Stocks: 65% of $600,000 x Growth of 11% = $432,900
- International Stocks: 25% of $600,000 x Growth of 12% = $168,000
- U.S. Bonds: 5% of $600,000 x Growth of -2% = $29,400
- Cash: 5% of $600,000 x Growth of 0% = $30,000
- Total: Growth of $600,000 into $660,300
Now, I’ll compare my portfolio’s performance to its benchmarks. Let’s say the benchmarks had these returns during the same year my portfolio grew by 10%:
- S&P 500: 14%
- S&P SmallCap 600: 20%
- S&P Developed Ex-US BMI: 19%
- Bloomberg Barclays US Aggregate Bond Index: 2%
- Bloomberg Barclays Global Aggregate Bond Index: 4%
- S&P US REIT: -9%
- Cash: 0%
If I could have achieved benchmark returns, my portfolio would have grown like this:
- U.S. Stocks: 65% of $600,000 x Growth of 14% = $444,600
- International Stocks: 25% of $600,000 x Growth of 19% = $178,500
- U.S. Bonds: 5% of $600,000 x Growth of 2% = $30,600
- Cash: 5% of $600,000 x Growth of 0% = $30,000
- Total: Growth of $600,000 into $683,700
In total, my portfolio would have grown to $683,700 or about 14% [($683,700 – $600,000) / $600,000)].
So, in this year, the “actual” portfolio didn’t do as well as it should have, given the performance of various economies as represented by the benchmarks.
Note that this portfolio and these returns are hypothetical and simply serve as a way to discuss the calculation of portfolio performance. In addition, index funds or ETFs may have slightly different holdings than their benchmarks and charge investors for their services, leading to different results. For example, instead of getting a 19% return with an international stocks fund, I may get 17% because of fund operating expenses or tracking errors (the deviation between benchmark and fund holdings). Further, this example is not meant to suggest that index funds always outperform individual stock selections.
The main idea is that when I ask myself “how I am doing?,” I should consider benchmarks associated with various asset classes.
How do you measure the performance of your portfolio?
Hello Julie Rains:
A very insightful article. Is it possible to find a ‘single’ benchmark that has more or less the same allocation as what we have? Given that there are so many indices for so many markets by so many companies. Or do we always have to pick and choose the benchmarks and weight them appropriately to find out their returns?
Many thanks.
Regards and respects.
Based on my research and understanding, you’ll need to weight your benchmarks in line with your desired or current asset allocation.
It’d be easy to compare a portfolio (designed to deliver a certain level of returns with a certain level of risk) to the S&P 500 benchmark. But it’d be unfair to the portfolio (and your portfolio manager) because a stock benchmark would likely be riskier than your portfolio.
The only time it would make sense to use a single benchmark would be if your assets were 100% allocated to that particular benchmark; for example, if you held all large-cap U.S. stocks, then you might compare your portfolio performance to a large-cap U.S. stock benchmark like the S&P 500.
Great info, Julie. So my question is what the standards for benchmarking are in the industry or when you use a brokerage. For instance, Berkshire has around 110 billion in cash and around 170 billion in stocks. When you chart Berkshire’s performance against the S & P using a site such as BigCharts the cash is not counted (which would be unfair as you suggested above). But what are the industry standards? Is this how they treat hedgefunds too when you compare its performance against the S & P 500? If I have $10,000,000 cash in my TD Ameritrade brokerage account and $10,000,000 of stock in the same account, will my portfolio performance against the S & P 500 only be calculated considering the $10,000,000 invested in stocks? That is the industry standard? Are you saying that there are at least two industry standards, one that can calculate “an overall brokerage return including no return from cash” vs the S & P 500 and an “overall return from stocks invested in” vs the S & P 500.
Thanks for your question. I’m approaching this exercise from the perspective of a regular investor who’s gauging the performance of her/his portfolio compared to benchmarks, not necessarily how the “industry” handles this exercise. To me, for example, if I invest in Berkshire Hathaway (which I do btw; disclosure), then I’d compare Berkshire’s performance to an S&P Index Fund. I’m investing in Berkshire to give me equity performance. If Berkshire gets that performance by holding cash and then snapping up shares of valuable companies on a downturn, then that’s great but it’s still to me an equity allocation, not a cash one. Similarly, I wouldn’t dig into the cash holdings of all the companies that make up the S&P and consider those part of my cash account.
Now that you mention it, I hold cash in my brokerage account and cash in a high-yield savings account. I think of those cash accounts very differently. One is to serve me as cash and I’ll expect a low return (to me even high yield accounts give low, cash-like returns). However, the idle cash in my brokerage is for my purpose to be invested later and is counted toward my equity return.
How would one measure performance of an existing account, minus trading fees etc?
For example if one invested £15,000 a year, but trading fees made up £1000 per year. Also how does one do it if stocks are bought and sold?
Are there tools one can use to benchmark?
Thanks
Jake W
You’ve posed a great question. Account fees and transaction fees (for the buying and selling) matter in your portfolio performance but they don’t affect the benchmark. The idea of the benchmark is to provide what I’ll call a “pure” performance, not muddied with fees, etc. It’s almost impossible to achieve the benchmark because most investors will incur some fees plus index funds and mutual funds don’t replicate benchmarks precisely. Still, the benchmark is the ideal to be compared with a real-life portfolio.
So you’d want to compare how your entire investment did with the benchmark. I would include all out of pocket costs such as the £1000 in trading fees plus the £15000 in my investment comparison. So I’d compare the example portfolio with a £16000 benchmark, not a £15000 one. (Investors don’t get points or credit for paying more in trading fees or doing more work by trading more often.)
You may also be thinking about adding money to your original investment throughout the year and wondering how to use a benchmark in that scenario — that’s something I’ve been thinking about and I hope to develop a tool for that at some point.
I hope that makes sense and answers your question.
Our manager purchased APGYX in January – Morningstar gives this fund 5 stars so here’s my question:
Current YTD Return is 9.74% – yet the Trailing Returns (%) Vs. Benchmarks YTD is -12.61% – as a novice investor this is challenging to decipher.
Comments/Input appreciated, thanks.
Thank you for your interest in this topic. My research points to the YTD return as 9.74% for APGYX (if bought at the 68.79 in January) and a possible Benchmark return of 12+% (looking at Fidelity’s Large Cap Growth Index Fund, FSPGX, which returned about 12.30% during the same time frame). I’m wondering if the trailing returns indicator was for the same period or another time frame.