A benchmark serves as a point of reference for measuring and analyzing how something else performs. Investing benchmarks allow investors to assess their volatility and return against a common standard.
In investing, benchmarks typically refer to indexes – compilations of dozens or hundreds of assets within a specific:
The goal is to generate a comprehensive representation of a niche’s average performance. Investors can use these indexes as a benchmark to measure their own portfolio’s outcomes against.
The two most popular types of indexes are arguably equity and fixed-income indexes.
Equity indexes track the performance of stocks that fit each benchmark’s agenda. Famous examples include the:
Fixed-income indexes track the performance of income-producing assets like treasuries and government or corporate bonds. Some well-known examples include the:
But equity and fixed-income indexes aren’t the only options. Benchmarks exist to track commodities, cryptos, derivatives, and precious metals, as well as tangible metrics like size and market sector. Some indexes even follow ideas, trends or themes like ESG or SRI investments.
When comparing your performance against a benchmark, you’ll want to choose an index that represents the same asset, sector and size.
For instance, if your portfolio is mostly large-cap stocks, you’ll probably find the S&P 500 useful. If you mainly hold small-cap firms, the Russell 2000 may fit better.
But what if you have a very diversified portfolio? In that case, you may have to divide your portfolio into sections to compare one at a time.
For example, you don’t want to measure emerging market performance against U.S.-based indexes. The same goes for asset types – a crypto index can’t tell you how your bonds are doing, and vice versa.
For a real-life example, we’ve pulled from our very own Clean Tech Kit.
One of this Kit’s holdings is the iShares Global Clean Energy ETF, which seeks to track the S&P Global Clean Energy Index. The ETF’s prospectus directly compares the fund’s performance against its given benchmark:
Image source: iShares
As you can see, the fund’s ten-year return before taxes is 11.93%, slightly outperforming the benchmark index’s 11.20% gains.
However, this is just one fund and benchmark – our Clean Tech Kit actually invests in three funds. For a truly comprehensive comparison, you’d have to compare each ETF against its underlying index. Importantly, you’ll also have to decide if each fund has chosen the correct benchmark to measure against.
Index benchmarks provide a yardstick for measuring your portfolio’s performance. But they aren’t static: each evolves over time, with new ones popping up to capture new assets, segments and trends.
And because they track past performance, benchmarks are limited to a one-way view of their assets’ health. Still, they’re useful tools for formulating, evaluating and adjusting your long-term strategy.
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