Should you benchmark your investment portfolio?

If you are wondering whether or how to benchmark your investment portfolio, this is must read for you.


Most investors and advisors measure the performance of their portfolios against benchmarks. They use different yardsticks to measure the performance of their portfolio. Some of these yardsticks are index returns, category returns, expected returns, last year’s gains, and inflation.

You need to pick the right benchmark and measure your portfolio’s performance against it. If the benchmark is outperforming your portfolio, you can also consider switching to the benchmark. Benchmarking is necessary even if your portfolio is helping you to achieve your goals.

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Let’s take a closer look at how you can pick the right benchmark and use it to analyze your portfolio:

What is a benchmark?

A benchmark is a point of reference or standard. You can analyze the return, risk, and allocation of your portfolio against it. Investors usually compare their portfolios and mutual funds with specific benchmarks.

You can use an index, ETF or another person’s portfolio as a benchmark. Many investors prefer to use an index or a few indices because they represent the average. However, there are many indices and you need to pick the right one.


Pick the right benchmark for your portfolio

Benchmarking is very important, especially when you start investing. It can help you to determine what returns are possible and which risks you are willing to take. A benchmark serves as a reference point and helps you to specify your preferences and priorities.

If you have been investing for a while, a benchmark can help you to measure your progress. It can also help you to think about how much you are willing to deviate from the plan.

A good benchmark needs to be:

Suitable The benchmark needs to be in line with your investment style. It should also align with your preferences and priorities.

Quantifiable The returns on the benchmark need to be measurable at frequent intervals.

Investable You need to have the option to give up active management and invest in the benchmark.

Definite The names of the securities that make up the benchmark and their proportions need to be clear.

Representative The benchmark should represent investors’ current views on the securities that constitute it.

Investors who want to outperform the market use equity indices to measure performance. The equity indices are not meant to measure the performance of diversified portfolios. A stock index provides higher returns with more volatility than a diversified portfolio.

Also read: Benchmark & its importance in Mutual Funds

Total Return Index (TRI) vs Price Return Index (PRI)

In the past, the Price Return Index (PRI) served as the benchmark for all mutual fund schemes. SEBI asked mutual funds to start using the Total Return Index (TRI) as the benchmark from February 1, 2018. The aim was to give investors a real picture of mutual fund performance.

A mutual fund generates returns through capital appreciation and dividends. Capital appreciation occurs when the market price of a security goes up. The PRI only captured capital appreciation. It ignored dividends. The TRI includes both capital appreciation and dividends.

The TRI helped to make the data more credible and transparent. The TRI will always be higher than the PRI because it includes dividends. Using the PRI alone exaggerates the outperformance of the index by a mutual fund, and this can be deceptive.

News about mutual funds outperforming benchmarks attracts investors. SEBI’s move to use the TRI aims to show mutual fund investors the real picture.

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Why you should use the TRI to assess mutual fund performance

The PRI did not include dividends. The dividend in an index is usually around 1.5% per year. As the PRI did not include dividends, it understated returns by about 1.5% per year.

The TRI tracks both capital gains and dividend payouts. It assumes the reinvestment of any cash distribution back in the index.

If we use the TRI instead of the PRI, the index returns will go up by between 1% and 1.5% per year. A mutual fund scheme that outperformed the PRI by 3% in a year will beat the TRI by only 1.5%. Mutual funds used to include dividends in their NAV, which helped them to raise their returns against the benchmark in the past.

Now that the TRI is being used, you may see that the outperformance of your mutual fund is much lower than before. In some cases, you may find that your mutual fund is underperforming the TRI.

If there is no outperformance or if it is small, you can consider other options. You can switch to a low-cost index fund or an ETF that tracks the index.

Also read: 8 points to remember while investing in a Portfolio Management Services (PMS)

The drawbacks of benchmarking your portfolio

Some analysts feel that benchmarking is of no use and it could even be dangerous. The financial services industry creates benchmarks to make people move their money around. Investors are in a constant quest for higher returns. These moves generate commissions and fees for the financial services industry.

Many studies show that less than 1 in 4 mutual fund managers beat the index in the long run. The outperformance is very small. The expenses and fees are higher than the outperformance, and this is before considering taxes on gains.

Some analysts think that trying to beat a benchmark index doesn’t make sense because:

  1. The investor has to take too much risk to get similar performance. This is fine when markets are rising, but it hurts when markets fall.
  2. The index does not pay any costs, expenses or taxes, but the investor does.
  3. The index does not have to distribute money for living expenses, but the investor does.
  4. The index benefits from stock buybacks, but the investor doesn’t.
  5. The index can replace a bankrupt company with another one at no cost, but the investor can’t.
  6. The index does not contain any cash and has no life expectancy, but the investor does.

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Final Words:

Benchmarking can be good or bad depending on how you use it. You need to focus on the things that matter most to you. Be conscious of your time horizon and try to preserve your capital. Have realistic expectations and aim for a rate of return that beats inflation. A big profit requires a massive increase in risk. Remember, you can recover from losses, but lost time never comes back.

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