Benchmarking Your Portfolio May Have More Risk Than You Think

During ripping bull markets, investors often start benchmarking. That is comparing their portfolio’s performance against a major index—most often, the S&P 500 index. While that activity is heavily encouraged by Wall Street and the media, funded by Wall Street, is benchmarking the right for you?

Let’s begin with why Wall Street wants you to compare your performance to a benchmark index.

Comparison-created unhappiness and insecurity are pervasive, judging from the amount of spam touting everything from weight loss to plastic surgery. The basic principle seems to be that whatever we have is enough until we see someone else who has more. Whatever the reason, comparison in financial markets can lead to terrible decisions.

This ongoing measurement against some random benchmark index remains the key reason investors have trouble patiently sitting on their hands and letting whatever process they are comfortable with work for them. They get waylaid by some comparison along the way and lose their focus.

Clients are pleased if you tell them they made 12% on their account. Subsequently, if you inform them that “everyone else” made 14%, you’ve upset them. As it is constructed now, the financial services industry is predicated on upsetting people so they will move their money around in a frenzy.

Therein lies the dirty little secret. Money in motion creates revenue. Creating more benchmarks, indexes, and style boxes is nothing more than creating more things to compare against, allowing clients to stay in a perpetual state of outrage.

This also explains why “indexing” has become a new mantra for financial advisors. Since most fund managers fail to outperform their relative benchmark index from one year to the next, advisors suggest buying the index. This is particularly true as the increasing market share of indexing (and passive, or systematic, investing in general) has made markets less liquid.