Benchmarks and Personal Financial Goals or “How am I doing?”

Like former Mayor of New York Ed Koch, one of the things people invariably ask their investment advisor, is ‘How am I doing?’  This is both an easy and hard question to answer.  It is easy because there are generally accepted rules as to how to measure investment performance. (For institutional level performance, these are the Global Investment Performance Standards (GIPS).)  It is difficult, because once you calculate that number, what does it mean, and what do you measure it against?  Was it a good return or not?

The quick and easy answer is that you should measure it against the appropriate benchmark.  Most asset classes have indexes that represent the performance of their overall market.  However, even these have issues.  For US Stocks, many people think of the Dow Jones Industrial Average, when they think of stocks.  However, The Dow consists of only thirty large cap stocks.  It is not truly representative of the US stock market.  Many mutual funds use the S&P 500 Index as their benchmark.  While this is better, covering 75% of the market value of US stocks, it is still mainly a US large stock index.  So where do small cap stocks fit in?  These are in such indexes such as the Russell 2000 and S&P 600 Index.  Indexes such as the Russell 3000 and the Dow Jones Wilshire 5000 Index cover practically the entire US market.  But how do you measure international stocks?  Currently the United States markets make up approximately 45% of the stock market value of all of the world’s stocks.  Therefore, if you concentrate on just the US indexes, you are missing over half of the stock market values available.  Indexes such as the MSCI All Country World Investable Market Index (ACWIMI) cover the entire world. 

In the bond market, most people refer to the Barclays Aggregate Bond Index (Agg) when discussing performance.  However, that is a US index, which does not include high yield bonds, or municipal bonds.  These have their own indexes.  International bonds are now widely available and need to be measured against their own benchmarks.   In addition, Real Estate Investment Trusts (REITs), commodities and hedge funds all have their own indexes and sub indexes. 

All of these indexes make it easy to measure the performance of different sections of the portfolio.  Just measure US stocks against a broad US Index, global stocks against the MSCI ACWIMI, US high quality bonds against the Barclay’s Agg , but against what do you measure the performance of the entire portfolio?  The textbooks tend to say against the broadest most appropriate index.  So a portfolio composed of 60% US stocks and 40% US Treasuries, Agencies and investment grade bonds would be best compared against a mix of 60% Russell 3000 or Dow Jones Wilshire 5000 and 40% Barclay’s Agg.  This would tell you how well the investment you had did against their benchmarks.  With a wider variety of investments, this can get complicated, but still measurable. 

Once this is settled, the next issue, is how well this did in achieving your own personal financial goals in light of your own time horizon and risk tolerance?  While some of this can be measured by how much you have allocated to what asset class, asset allocation does not cover everything.  For example, a defensive stock allocation may underperform in rising markets, but still achieve ones goal.  This will show up as underperformance versus the broad indexes, but not against your goals.  In this day and age, of constant information bombardment, it is important to keep an eye on what is right for you.  With thousands of mutual funds, stocks and ETF’s straining for your attention, it is easy to lose sight of that and be caught up in the daily hoopla.  Stay focused.