Benchmarks

Benchmarks help us gauge our progress, performance, and results.  As humans we compare ourselves to others more often than we think, consciously and subconsciously.  Sometimes this can be a healthy behavior, while other times it can be a detriment.  Kids racing each other at a park, constant sibling rivalries (usually about the most ridiculous things), competition for a promotion at work, an inner motivation to improve oneself by improving one’s fitness from one point of time to the next, reading more books than last year, or earning more money from one year to the next; all involve comparing one result to another over a given timeframe.  Comparison and competition go hand in hand.  It is paramount to compare similar things to each other though.  At one time, it would be silly to gauge my performance by me beating my son in a race.  I’m older, been doing it for longer, have longer legs and should be faster and stronger, but he just beat me recently…and I’m still trying to cope with it.  Benchmarks need to be evaluated for their accuracy and this benchmark recently changed.  The comparison should be apples to apples. 

This leads me to something that should be addressed, especially when it comes to investing and specifically this year.  After a tough last year where it seemed all areas of the market experienced losses, we are experiencing a rebound this year.  As I am typing this, the “market” (Standard and Poor’s 500 Index) is up 14.54% (7/10/2023).  Should we be overly excited with this increase, be cautiously optimistic since the Nasdaq Composite is up 31.12% for the year or totally dismiss it since the Dow Jones Industrial Average is only up 2.21% for the year?  When people refer to the “market”, they can be referring to any of these indexes (or indices, both are acceptable versions of the plural form of index, by the way), or benchmarks.  These are all ways to gauge how the “market” is doing, but they are not all the same and far from a good apples to apples comparison.  There are a lot of other indexes that are used as benchmarks in the investing industry.  For instance, the Bloomberg US Aggregate Bond Index would be a good index to use to know how the bond market is doing, but a poor benchmark for international markets.  The MSCI EAFE or FTSE 100 would be better alternatives for this.  A closer comparison would be the Russell 2000 compared to the Wilshire 5000, but still not apples to apples, since the Russell 2000 is for small companies and is more volatile, while the Wilshire is meant to be a broad-based representation of the domestic investment market.  While this can be confusing, it is important to know what you may be comparing your investable life savings to and ultimately could be using to make very important decisions. 

With all the indexes to pick from, the most widely used are the Dow, S&P 500, and the Nasdaq.  All are used to gauge the equity market, or stock.  But as noted before, not the same.  Besides the vast difference in returns between the three this year, there are other differences.  The wide discrepancies of returns are due to what they are representing.  The Nasdaq is heavily made up of Technology stocks.  Its high return makes sense since the Technology sector of the market is up 40.7% this year according to Franklin Templeton.  While investors enjoy those returns in a good year, the same sector was down over 30% last year.  The middle ground index, S&P 500, is made up of a more diversified lineup of companies but is Capitalization Weighted (so is the Nasdaq), or Market Cap weighted.  Essentially, what this means is that bigger, more valuable companies are given a bigger percentage of the Index.  This is calculated by multiplying the outstanding shares of the company by the price of one share.  So, today the S&P 500 is up over 14% but the weighting is overweight to Technology and bigger, more valuable companies like Apple, Alphabet (formerly known as Google), Microsoft, and Amazon.  These companies are up between 32-50% for the year and make up a large part of the index, skewing the average.  These companies were also down 30-50% last year creating quite a rollercoaster for the past two years and a feast or famine situation.  Compare this to the steady Dow Jones and its low return for the year, which is only 30 companies (which many people think doesn’t reasonably represent the vast market).  This index is Price Weighted, which is calculated by adding all share prices and dividing that by the amount of companies.  This difference, and that it also excludes many stocks that are in the S&P, especially Amazon and Alphabet, accounts for the discrepancy of returns. 

Comparing a portfolio to any of these indexes is not a bad thing but should be done in the right context.  Rarely an investor’s portfolio is identical to one of these indexes.  Their tolerance to risk is probably not as high to weather the down years as well, creating a risk of selling at the most inopportune time.  A diversified portfolio tailored to the investor and their goals is a time-tested approach, and when partnered with accurate expectations for fluctuations, it is an excellent way to achieve one’s goals for themselves, loved ones, and causes they hold dear.  It’s easy to see a person’s money and investments as numbers and percentages, but it is important to remember to see it as resources to accomplish meaningful things and hopefully create cherished memories.

Written by Leon Bennett, CFP®, Chief Operating Officer, Majestic Financial, Financial Consultant, RJFS

Disclosures:
*Any opinions are those of Leon Bennett and not necessarily those of RJFS or Raymond James. The information contained in this blog does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Please note, changes in tax laws may occur at any time and could have a substantial impact upon each person's situation. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.
*Certified Financial Planner Board of Standards, Inc. (CFP Board) owns the certification mark CFP® in the United States, which it authorizes use of by individuals who successfully complete CFP Board's initial and ongoing certification requirements.
*The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market.
​*The Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index, which represent approximately 8% of the total market capitalization of the Russell 3000 Index.
*The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States & Canada. The EAFE consists of the country indices of 22 developed nations.
*The Wilshire 5000 Index is an unmanaged index of 5000 stocks traded on NASDAQ and the exchanges.
*The NASDAQ composite is an unmanaged index of securities traded on the NASDAQ system.
*Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor's results will vary. Past performance does not guarantee future results.
*The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. 
*The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market.