When you want to gauge performance, it's necessary to have something to compare against. Race cars have lap times, microprocessors use clock speeds and investments use benchmarks. For serious investors, benchmarking is essential. But how can you pick an appropriate benchmark for your portfolio? Here's a primer to help you get started.What Is a Benchmark? A benchmark is a tool for measuring the performance of an individual investment or
Blended Benchmarks Even though investors have a lot of benchmark choices, don't be surprised if there isn't one that represents your portfolio perfectly. One way around this is with blended benchmarks. "Blending" benchmarks is a way for investors to take different benchmarks and weigh them to create a unique hybrid. As an example, let's say that your stock portfolio is made of 80% small-caps and 20% large-caps. To have an appropriate comparison point, consider a blended benchmark that's 80% Russell 2000 and 20% S&P 500. T. Rowe Price's Ward agrees with this approach of "proportionally blending benchmarks to create a hybrid benchmark that's an accurate representation of your portfolio." Benchmark Watch So how often should you compare your portfolio against your chosen benchmark? Ultimately, the answer involves a two things: how actively you participate in your portfolio and the kinds of investments you're into. Active investors (with more portfolio
turnover ) will want to be more active in checking their benchmarks, for the simple fact that they're making decisions that can affect their performance more frequently than investors who rarely make changes to their portfolios. Likewise, people involved in riskier investments (like small-cap stocks) will want to be more vigilant in comparing against their benchmarks than people who own less volatile ones. Comparing your portfolio doesn't have to be a painful or difficult process, but checking the state of things whenever you make decisions is a pretty sound move. Clark says, "at a minimum," you should check your benchmark "when you're seeking to re-evaluate or rebalance your holdings." Beating Your Benchmark As important as benchmarks are for investors, it's important not to focus too closely on the benchmark itself. As an individual investor, benchmarks aren't the end-all and be-all; they're tools, nothing more. "I always get concerned when people just try to beat benchmarks. For certain mutual funds, that may be what they're trying to do, but as a personal investor I think it may be kind of dangerous to get into that game," admonishes Ward. So while a benchmark is a useful tool to determine how well your portfolio is "performing," focusing on beating a specific benchmark instead of meeting your unique investment goals can be a big mistake. That's why it's important to re-evaluate your investments and the benchmarks you measure them against on a regular basis.