Anatomy of a Benchmark: Everything You Need to Know About Benchmarks

What Are Investment Benchmarks?

The dictionary defines a benchmark as "a point of reference for measurement." This is the measuring stick we use to assess our portfolio performance over the long term.

Commonly Used Benchmarks

The most commonly quoted benchmarks are indices such as the Dow Jones Industrial Average, the S&P 500 and the MSCI EAFE. The Dow is composed of 30 large U.S. stocks, the S&P 500 of the large U.S. stocks and the EAFE is comprised of stocks from Europe, Asia, and the Far East.

Identifying the Appropriate Index

The appropriate index for your needs is not always easily identified by its name or popularity. For example, most people have heard of the Dow Jones Industrial Average because it is quoted in the news throughout the day. However, many people may not be aware that the Dow tracks only 30 stocks of America’s largest companies — not a very reliable source for comparison if your portfolio is a diversified mix of domestic and foreign stocks and bonds. Since all of our clients have diversified portfolios, none of the often-quoted indices would make a good benchmark. For one thing they are all stock and do not hold any bonds.

As investment managers we not only want high returns for our clients but we want high, risk-adjusted returns. That is, we want our clients’ portfolios to grow but in the least volatile way possible. To achieve this, we diversify our clients’ holdings into both stocks and bonds. The result is a portfolio that doesn’t fall as far or as fast as an all-equity index in a falling market. In a rapidly rising market our clients’ portfolios will lag the all-equity index, however, due to our investment strategy, which includes a focus on international holdings including emerging markets, our clients have out-performed the S&P 500, Dow, and EAFE over the long-term. The bottom line is that your portfolio moves differently from common indices on a day-to-day basis so if you see that the Dow plummeted one day, your portfolio most likely did not fall as far.

How do we at PFC benchmark?
We use a hybrid benchmark which is a combination of both equity and bond indices and is based on your risk tolerance and time horizon. In addition, we benchmark individual funds against their own investment category to make sure they are competitive. From time to time you will see us switch out a fund in favor of a fund we feel will perform better over the long term.