“How bad has it been for my investments this year?” is naturally an essential question for any investor. There is another question, however, that I believe should be asked: “How did my investment returns compare with other similar investments?.”
Unfortunately, many investors fail to compare their returns with any benchmark that could compare what the overall market returned for similar risk-level investments. Suppose the returns from your investments are much lower than overall market returns or lower than similar asset classes². In that case, you may pay higher fees than necessary or employ counter-productive strategies. An asset class is a group of securities that share similar characteristics, perform comparably in the marketplace, and are governed by the same laws and regulations. Major asset classes include stocks, bonds, cash, real estate, and commodities.
The collective returns of a particular asset class are shown through indexes. ¹
¹An index is a measurement used to calculate the weighted average returns of various asset classes and subsets of asset classes such as stocks, bonds, real estate, commodities, etc.
²An asset class is a group of securities that share similar characteristics, perform comparably in the marketplace, and are governed by the same laws and regulations. Major asset classes include stocks, bonds, cash, real estate, and commodities.
To use an analogy to describe a benchmark or index, consider real estate “comps,” which compare similar residential values in a given area or region. A prospective buyer or seller will research the comps to determine the general price level of similar home sizes, ages, locations, etc. But you cannot invest in the comp because it doesn’t represent ownership of anything; it’s only a collective measurement of value for informative purposes.
Several indexes are published by various companies, including stock indexes, bond indexes, real estate indexes, and commodity indexes. As with real estate comps, direct investment in published indexes is impossible. Investment companies, however, can create their version of a related index by closely duplicating the published indexes and offering them to investors as mutual funds or ETFs (i.e., Vanguard 500 Index™).
On average, two-thirds of actively managed funds do not outperform their benchmarks, and the reason is mainly the additional unnecessary costs. But a careful analysis may reveal that your investment returns are lagging behind the market by more than just the costs of your funds. In this case, it may make sense to research further to identify the reason.
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It will not always be possible to compare your investments with a benchmark due to the inability to identify which asset class your investments should be labeled, such as “balanced funds, asset allocated funds, target date funds, and other investments that don’t separate asset classes or whose names are not identified to a particular asset class. If you are serious about tracking your returns to what the market yields for similar investments, asset-class funds (large-cap, small-cap, etc.) should be considered for better comparison to indexes.
If you would like to discuss your portfolio or help compare your results with appropriate benchmarks, don't hesitate to contact us to schedule a no-charge consultation with Anthony B. Carr, CPA, CFP.
**Past Performance is no Guarantee of Future Results
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There are no guarantees that strategies will be successful.