Keeping up with the S&P 500

Why Isn’t My Portfolio Keeping Up With The S&P 500?

This is a question I have encountered recently and it’s a good one. Before answering though I have to propose another question, “Why should it?” Or, perhaps more specifically, “Is the S&P 500 (or the Dow for that matter) a proper benchmark, i.e., the proper comparison to make versus your portfolio?” The investment returns in a portfolio can be looked at from many perspectives.

Is the S&P the right benchmark?

The S&P 500 is an index of 500 of the largest companies listed on US stock exchanges. Thus it is considered a good representation of the US stock market. Last year it returned about 13.7%, including dividends. During the final three months of last year it seemed the media constantly reminded us that the Dow and S&P were hitting highs for the year. The statements show up in January and you find yourself disappointed because your accounts weren’t up nearly that much. Suddenly it seems like you’ve failed or “should have” done better.

Is the S&P even an appropriate measure of comparison? Only if your portfolio is comprised of 100% large company US stocks (or mutual funds) which few portfolios are these days.

Investment returns and diversification

The very definition of what it means to be diversified seems to have shifted in the last 20 years or so. It used to be that owning a mutual fund that tracked the S&P 500 was deemed adequate, even good diversification. If you were in your 30’s it was considered wise to have 100% of your investment assets in the index. As you aged you would gradually add bonds to your portfolio. By the time you retired bonds might comprise 50% or more of your portfolio. If your portfolio consisted of  50 percent bonds last year (which appreciated in the low to mid single digits) there is no way you would expect to see double-digit returns on your portfolio.

Research now suggests there is a diversification benefit to owning other types of equities (stocks) and bonds in our portfolios. In addition to large company US stocks additional diversification might include: small company US stocks, large and small international companies as well as emerging market stocks. Likewise with bonds: beneficial diversification might include government, corporate bonds, and/or munis. High yield and international bonds may round out the mix. There may be allocations to short, intermediate and long-term bonds.

What is a good benchmark?

Choice of an appropriate benchmark has many complexities and it is a challenge for us as investors to know which metrics will tell us if our returns are good. Many investment managers are looking into the concept of “custom benchmarks” that can be tailored to each specific client portfolio. For now we need to look deeper at the percentages we own in each of the sub-asset classes and what those respective investment returns were.

As to last year (2014), the S&P 500 was the “star” asset in that it had the highest returns. International and emerging market stocks were down. Short-term and high yield bonds were up only two percent. If you hold other asset classes in your portfolio it isn’t a valid comparison to suggest you “should have” kept pace with the S&P.

Last year was a reminder that diversification works and that sometimes we don’t care for the results. Comparing to an inappropriate benchmark contributes to the feeling of not doing “well enough.” Equally misleading is the opposite problem, thinking you’ve done well in comparison to a poor performing (and inappropriate) benchmark. The different flavors of stocks and bonds that are part of a well-diversified portfolio all have different risk and return characteristics. Compare your investment returns with a benchmark of similar composition.

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