How to Benchmark Your Portfolio
If you're evaluating your portfolio, make sure you're using a benchmark that reflects what you're actually trying to see.
"How am I doing?"
It's one of the most basic questions an investor can ask, but answering it isn't always straightforward.
For starters, common yardsticks of market performance, such as the S&P 500 or the Bloomberg Barclays U.S. Aggregate Bond Index, assume that an investor is fully invested in that asset class--all stocks or all bonds. Few investors are. Comparing your performance with that of an S&P 500 index fund, or even a total stock market index fund, is a poor choice unless your portfolio is 100% U.S. stocks. Instead, it's better to compare your results with a benchmark that roughly matches your own portfolio's asset allocation; I'll talk about where to go for that type of intelligence below.
Yet even as such a bespoke benchmark is an advance over a single-asset-class benchmark like the S&P 500, it serves the single goal of helping you assess your security selection. It makes no judgment about your asset-allocation choices. For example, you may have managed to shred the Bloomberg Barclays U.S. Aggregate Bond Index's performance with your all-bond retirement portfolio. But if you're only in your 30s, you may still not meet your goals because you've stuck with a portfolio that's too conservative given your life stage. What you need more than anything is a check on the reasonableness of having so much in bonds in the first place.
No matter what type of "How am I doing?" question you're attempting to answer (and you'll probably have more than one at various points in time), here are some benchmarks you can use to help you make a well-considered assessment.
If you want to see whether your security choices have added or subtracted value: As noted above, one of the best ways to keep tabs on whether you're helping or hurting returns with your stock, mutual fund, or exchange-traded fund selections is to create a custom benchmark of inexpensive index funds or ETFs that mirrors your portfolio's asset allocation (or your target allocation). Such a benchmark is not just a worthwhile check of your security-selection acumen but also a lens into whether you could be running a portfolio that's simpler and cheaper than what you have.
Start by using Morningstar's Instant X-Ray functionality to determine your portfolio's current asset allocation; you can then use that allocation to inform the weightings for your custom benchmark. For example, let's say X-Ray shows that you have 42% in U.S. stocks, 22% in foreign stocks, 23% in bonds, and 13% in cash. Assuming you have a $1 million portfolio, your custom benchmark could consist of $420,000 in Vanguard Total Stock Market ETF (VTI), $220,000 in Vanguard Total International Stock ETF (VXUS), $230,000 in Vanguard Total Bond Market ETF (BND), and $130,000 in a good low-cost money market fund such as Vanguard Prime Money Market (VMMXX).
The quickest way to set up such a benchmark portfolio to monitor against your own portfolio is to do so via Instant X-Ray. At the top right of the X-Ray page, click on Save as a Portfolio, name your benchmark portfolio, and click Save again. If, over time, it turns out that you're consistently lagging, you might consider calling it a day and going all-in with total market index funds, much as Taylor Larimore suggests in his book, The Bogleheads' Guide to the Three-Fund Portfolio.
If you want a quick view of how you're doing: Setting up a custom benchmark is one of the best ways to make an honest assessment of your security choices given your asset allocation. But if you’re seeking a quick and dirty gauge, there are a few metrics you could turn to that are an improvement over all-stock indexes like the S&P 500. One is to go to the Fund Category Performance page and compare your performance to the allocation category that most closely resembles your own portfolio’s equity weighting. For example, if your portfolio holds a 60% equity weighting, you’d use the Allocation—50% to 70% equity Morningstar Category. That's a blunt instrument, in that it doesn’t take into account your precise equity weighting or your portfolio's holdings in cash or international stocks, but it’s better than using a fully invested, no-cost benchmark like the S&P 500.
Alternatively, you could find the Morningstar Lifetime Allocation Index whose asset allocation most closely mirrors your own, then compare your portfolio's performance with that of the best-fit index here. (The Lifetime Allocation Indexes and their performance are toward the bottom of the page.)
If you want to gauge the reasonableness of your portfolio’s asset allocation: The preceding benchmarking jobs all assume that you're working with some type of asset-allocation target and that you're comfortable with it. Based on my interactions with investors, that's not always the case; many investors view asset allocation as black-boxy and they don't know where to start. Here again, the Morningstar Lifetime Allocation Index weightings can be a guide. My various model portfolios for retirement savers and accumulators harness the same general methodology and can also be useful for benchmarking purposes. Good target-date funds like those from Vanguard and BlackRock can also provide a window into what professional asset allocators recommend for investors with varying degrees of proximity to retirement. Of course, these are one-size-fits-all benchmarks; they may not fit each and every situation, as discussed here.
If you want to see if you're on track to reach your goals: Ultimately, this is the mother of all benchmarking questions, and it's one that we should all ask ourselves at least once a year, ideally as part of an annual portfolio review. I like Fidelity's age-based retirement savings targets for a quickie view of whether a savings program needs to be stepped up. Vanguard’s Retirement Nest Egg Calculator considers a few more variables and is easy to use. If you have a bit more time, you can turn to a more holistic retirement-savings calculator that factors in numerous variables, such as asset allocation, tax treatment of investments, and Social Security. The Bogleheads site has a useful compendium of such calculators, many of them free, including T. Rowe Price's Retirement Income Calculator and The Flexible Retirement Planner. Because all of these calculators employ different methodologies--and because the viability of your retirement savings/spending plan is such a crucial question--it is worthwhile to sample a few of them for a range of opinions.
Christine Benz does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.