Reviewing performance against the right benchmark

A return means little on its own. Compare it with a benchmark that matches what you actually own.

Benchmark Blended benchmark Excess return Time-weighted return

Why you need a benchmark

'My portfolio made 8%' could be good or poor depending on what the markets you invested in did. A benchmark is a reference, usually an index, showing what a simple version of your strategy would have returned.

Match the benchmark to the mix

Comparing a 70/30 stock/bond portfolio to an all-stock index is unfair in both directions: it looks bad in strong stock years and great in crashes. Build a blended benchmark instead: 70% × stock index return + 30% × bond index return.

Also compare like with like: after fees, and over the same dates.

Contributions distort simple returns

If you added $5,000 during the year, your balance grew partly from your own deposits. Dividing ending balance by starting balance overstates performance. Many brokers report a time-weighted return, which removes the effect of deposits and withdrawals. Use that when comparing to a benchmark.

Review process, not just numbers

One year is noise. When reviewing, ask: is the allocation still right for my goals? Did I follow my rebalancing rule? Are fees what I expected? Changing strategy after every underperforming year usually means buying what just did well.

Worked example

Grading a 70/30 portfolio (hypothetical returns)

Portfolio (time-weighted, after fees): +8.0%.
Stock index +10%, bond index +3%.
Blended benchmark = 0.7 × 10% + 0.3 × 3% = 7% + 0.9% = 7.9%.
Excess return = 8.0% − 7.9% = +0.1 point — roughly in line with the benchmark.
Against the all-stock index (10%) it would wrongly look like a 2-point shortfall.

Pick the benchmark that mirrors your allocation. The wrong comparison produces the wrong conclusion.

Common misconceptions

“If I beat the market this year, my strategy is proven.”

One year is heavily luck. Judge over long periods and against a fitting benchmark.

“My balance went up, so my investments did well.”

Deposits raise the balance too. Use a time-weighted return to judge the investments themselves.

Checkpoint