How do you know if your retirement savings program is on track? Can you tell if your investments are doing what you need them to do? One way is through appropriate benchmark selection and performance monitoring.
Think about the way a school district measures and monitors the performance of its students. Report cards demonstrate how students do in class. Standardized tests, like MCAS in Massachusetts, provide additional information by measuring student knowledge using specific yardsticks.
Similarly, choosing a benchmark can give you a better grasp of your investment plan. Selecting the right benchmark is critical in order to get performance results that provide real insight. It is also an important next step once you’ve figured out your risk tolerance and risk composure, the subject of our post from last week.
In some circumstances, an absolute target, such as achieving 5% return per year, might be the right benchmark. For most people, however, understanding their portfolio’s relative performance compared to a broad market measure – an index that tracks a group of securities – is the best way to monitor results.
Indexes come in many shapes and sizes and can have very different profiles. When asked to name a market index, the Dow Jones Industrial Average or the S&P 500 Index are two that come to mind for many people. But there are more indexes that measure stock market performance than there are publicly-traded stocks in the US! So picking the right benchmark, or combination of benchmarks, can be a real challenge. The Financial Industry Regulatory Authority (FINRA) makes some good suggestions for selecting a benchmark.
At Laurentide, we believe that most investors are well served by holding a broadly diversified portfolio: in terms of securities, sectors, styles and regions. From our perspective, the 30-stock Dow falls short of qualifying as the best choice for a measurement tool. You need a benchmark that is broadly diversified, too. For many of our investors, we use benchmarks made up of the MSCI World Index (1,650 securities from 23 countries) and the Bloomberg Barclays Aggregate Bond Index, approaching 10,000 US dollar-denominated bonds.
Peter Lynch, the well-known and now retired Boston-based fund manager, was fond of saying “know what you own, and why you own it.” We concur. We also believe investors should know what’s in their benchmark index, and why they’re using it.
Rob Kania is Principal and Co-Founder of Laurentide Advisory.