How to Create a Benchmark for Your Portfolio

Measuring the performance of your portfolio can help you determine whether or not you need the services of a professional advisor. While absolute performance is nice to look at, it is more important to look at relative performance. To do that, you need to create a valid benchmark.

Difficulty: Moderate

Instructions

Things You'll Need:

• internet

1. First look at your stock/bond split in your asset allocation. This will tell you the appropriate weights for each component in your personal benchmark. For example an 80% stock, 20% bond portfolio should not be compared to a 100% stock index like the S&P 500. Your 85/15 portfolio by design will have lower expected returns (but also less volatility) so it is a bit like comparing apples to oranges.

2. Further break down the stock portion into domestic/international. For example, 75% US stocks, 25% foreign.

3. Now you can create a decent benchmark. It will be an appropriately weighted average of the returns of the asset classes in your portfolio.
   
   You can get the asset class returns from an appropriate tracking index or ETF/mutual fund. Make sure you choose something close in composition to your own portfolio. For example, if you hold no small stocks, it makes no sense to use an index that includes small caps.
   
   For example the above, your benchmark would include 20% bond return + 60% US stock return + 20% foreign stock return, where 60% is 75% of your total 80% stocks.
   
   If bonds returned 5%, US stocks 10% and foreign stocks 12% then your benchmark return is (.2*.05 + .6*.10 + .2*.12) = 9.4%

4. As you become comfortable, you can further slice up your portfolio to get a more accurate benchmark. Examples would be breaking down US stocks into small/large or foreign stocks into developed/emerging markets. Bonds could be divided into ratings/duration. Other asset classes like REITs or commodities could be added.

5. The important step is what to do with this data. If you find yourself severely under-performing your benchmark over a period of many years, you should examine the causes. Are you using expensive mutual funds? Are you trading too much and losing money to commissions? Are you acting emotionally and buying high and selling low? Once you discover the behavior it will be up to you to work to fix it or remove yourself from the process and turn over your investments to a reliable low-fee advisor.