How to Create Benchmark Index for a Balanced Retirement Fund

A benchmark index measures the prices of financial instruments or securities
A benchmark index measures the prices of financial instruments or securities (Image: Thinkstock/Comstock/Getty Images)

A balanced retirement fund refers to a portfolio of securities or mutual funds that invest in at least two broad asset classes or security types, anchored around stocks and bonds. Other asset classes may be added to the mix and these may be refined further to achieve broader diversification or other investment objectives. Regardless, the percentage of portfolio assets allocated to each asset class will vary based on an investor’s goals and objectives, investment time horizon and tolerance for risk. To be effective, a benchmark index has to track these asset classes at the appropriate percentage allocations over time.

Things You'll Need

  • Balanced retirement fund asset classes and allocation percentages
  • S&P 500 Index 2010 total return performance
  • Barclays Aggregate Bond Index 2010 total return performance

Identify the asset classes and securities that make up the balanced retirement fund. A common retirement strategy is to rely on investments in stocks and bonds.

Establish the percentage of net assets invested in each asset class. For example, one retirement fund strategy advocated for individuals who are today between the ages of 54 and 58 who plan to retire in the year 2020 is to adopt a portfolio allocation consisting of stocks and bonds, with 66 percent invested in stocks and 34 percent in bonds. As the individual approaches retirement, the emphasis will shift in favor of bonds.

Select the securities market indices that best reflect the retirement portfolio’s asset classes and security types and obtain their total return performance numbers for the applicable time interval. The S&P 500 Index measures the total return performance of 500 large capitalization U.S. stocks. It is often used as a proxy for the total market in the U.S. because it covers about 75 percent of U.S. equities. In a similar fashion, the Barclays U.S. Aggregate Bond Index is a broad based bond yardstick used to measure the total return performance of U.S. bonds. It consists of investment grade U.S. dollar denominated bonds, including U.S. government, corporate and mortgage backed securities.

Calculate the benchmark index, using the S&P500 Index and Barclays Aggregate Bond Index. To construct a blended benchmark index for calendar year 2010, take the performance of each index and weight it on a 66 percent/34 percent basis. The S&P 500 Index returned 12.78 percent in 2010 while the Barclays Index produced a total return of 6.5 percent.

Calculate a benchmark index for 2010 reflecting a blended return as follows: 12.76 percent multiplied by 66 percent plus 6.5 percent multiplied by 34 percent. The resulting benchmark index return is 10.6 percent (8.4 percent +2.2 percent). This is the yardstick for 2010 against which the balanced retirement fund should be compared for relative performance evaluation purposes.

Tips & Warnings

  • Additional indices should be added to reflect any additional asset classes that comprise the balanced retirement fund, in the appropriate percentages.
  • After the first year and each year thereafter, the benchmark index should be updated to reflect the latest available data. This applies both to the balanced retirement fund's asset allocation index performance results.
  • A significant variation in any given year between the results achieved by the balanced retirement fund and that of the benchmark index may suggest a possible calculation error. Double check results by recalculating the benchmark index.

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