Picking A Meaningful Benchmark

Every now and then I’ll run across someone comparing the performance of their portfolio against the incorrect benchmark. For example, if your portfolio was only blue-chip Canadian stocks and you surmised that your investing prowess is superior because your portfolio’s returns were better than the S&P 500 over the last decade your reference is almost meaningless. In this case your benchmark should be the S&P/TSX 60 Index.

But what about those who have a portfolio consisting of some US stocks, Canadian stocks, some international stocks and a smattering of domestic bonds? How do you know if your portfolio measures up? In this case you must create your own weighted-average benchmark.

For example let’s assume that our investor has 35% of his stocks in blue-chip Canadian stocks, 25% in a broad selection of US equities, and 40% of his portfolio invested in individual Canadian bonds of various maturities, credit ratings and issuers (Government and Corporate bonds). If his overall portfolio return was 4.2% for the last calendar 3 years, is this good?

Well to create a meaningful benchmark you would need to create a weighted-average benchmark based on the indices out of which he has picked his investments. In this case it might be:

35% x S&P/TSX60 Index + 25% x S&P 500 Index + 40% x DEX Universe Bond Index

Let’s create some data (these are not actual performance figures, I’m making them up) for the last 3 years:

S&P/TSX60 Index 3 Year Average Return: 8.5%
S&P500 Index 3 Year Average Return: 4.5%
DEX Universe Bond Index 3 Year Average Return: 4.5%

In this case the calculation for the weighted average benchmark performance would be:

35% x S&P/TSX60 Index + 25% x S&P 500 Index + 40% x DEX Universe Bond Index

= (35% x 8.5%) + (25% x 4.5%) + (40% x 4.5%)

= 2.975% + 1.125% + 1.80%

= 5.90%

In this case, the investor’s portfolio’s average annual 3 year return of 4.2% has lagged the appropriate benchmark and it might be time to analyze why.

Preet Banerjee
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