Benchmarking my portfolio
Investors tend to gravitate to financial products before financial plans. I believe that is a mistake. I believe regardless of whether you own mutual funds, Exchange Traded Funds (ETFs) or invest in some individual stocks for passive dividends like I do, what you own in your portfolio is less important than ensuring you have a diversified portfolio, which is integrated with a plan you can stick with over time. I believe it’s not the investment products that necessarily kill your financial plan over time it’s your behaviour – bad decisions, biases and more.
Even if you have a plan you’ve been sticking to, it remains important as an investor to understand “how you’re doing” when it comes your portfolio performance.
Today’s post will highlight how my portfolio has performed over the last few years compared to a few indexed products and my thoughts about benchmarking in general.
What is a benchmark?
Simply put, a benchmark is a standard against the performance of a security or set of securities can be measured. Generally speaking, broad equity market and bond indices are used for this purpose. There are dozens (if not more) benchmarks investors can use. Here are a few popular ones:
S&P/TSX Composite Index – Canada
This is probably Canada’s best-known benchmark index. This index tracks about 250 companies listed on the Toronto Stock Exchange, with financial, energy and materials companies making up the bulk of the equity market.
The S&P/TSX 60 – Canada is another index used to benchmark against Canadian large cap companies; it holds 60 large cap companies.
Dow Jones Industrial Average (DJIA) – U.S.
This index is one of the oldest around, created in 1896 by the founder of Dow Jones & Company and the Wall Street Journal. The index follows the stock performance of 30 large American companies.
S&P 500 – U.S.
This index is made up of 500 large-cap U.S. companies; this index is one of the most widely used benchmarks of U.S. equity performance.
MSCI World Index – Global
This index tracks large and mid-size company stocks in developed markets from around the world. This index is most often use to benchmark against Global equities (including Canada and US). At the time of this post the composition is roughly 60% U.S. market, 9% Japan, 7% United Kingdom and the rest of the developed countries from around the world (including Canada) comprise a lower percentage from there.
MSCI EAFE Index – Global
Like the World Index, this index was created by Morgan Stanley Capital International (MSCI) however this one tracks major international equity markets in different compositions, for example there is more weight in the index from Japan, Europe and Southeast Asia.
What about bonds?
There are also bond indices, and for Canadian bonds in particular, there are a few indices to benchmark against – the main one being the Universe Bond Index. A quick Google search will show you that the iShares product XBB – seeks to provide income by replicating, to the extent possible, the performance of the FTSE TMX Canada Universe Bond Index, net of expenses.
What does all this mean to you and me? It means you have a number of choices or combinations of choices to benchmark your portfolio against.
When it comes to benchmarking my Canadian dividend stock portfolio, I think a decent benchmark for me is one of the oldest ETFs around: ETF XIU.
This ETF holds Canadian banks, telcos, utilities, energy and industrial stocks, similar to my individual stock holdings – companies that have paid and raised their dividend consistently over the recent years.
- The last time I checked (in preparation for this post) the 5-year total return for IXU was about 6.5%.
- My performance: over the same period my portfolio performed close to 8%.
My thoughts about benchmarking
At the end of the day, I think monitoring your portfolio against a benchmark can help you understand if the portfolio you’ve designed will meet your long-term investment objectives, but more importantly call out any major market underperformance for the financial advice you’re paying for.
The challenges in using any benchmark data against your portfolio is accuracy and timing.
- Benchmarking will not accurately account for your risks taken (to earn investment returns to date). It’s just a performance tool for a point in time.
- Benchmarking is a lagging indicator. Some critics of this post will likely point out five years is too short to suggest any meaningful success for my portfolio. That’s fine. However with 20 years of benchmarking data, that’s a longer period, but if I find out I’ve significantly underperformed the Canadian market over that period, then it’s too late really for my portfolio. I’ll be in retirement.
When it comes to investing, investors need to remember they are playing a zero-sum game.
That is, half of the investor dollars will outperform and the other half will underperform the market average. Many investors do themselves a huge disservice by paying steep commissions, paying high money management fees, succumbing to administrative costs and so on. Investors need to know all of these costs work against them to reduce their investment returns over time.
This is why a passive investing approach using indexed funds is so widely touted. This approach minimizes portfolio turnover and costs, to deliver portfolio returns close to the market average.
What’s your take on using a benchmark? Do you know how your DIY portfolio is doing?