Did Your Portfolio Beat the Benchmark?

What’s the goal of investing? Many investors will simply answer, “Returns.” Or, more specifically, “Better returns.” But how do you measure returns? The answer is not as straightforward as you might think. What’s the benchmark? The S&P 500? What if your portfolio is nothing like the S&P 500? What if you have a substantial allocation to bonds? Or what if you’re heavily invested in the international or emerging markets? Shouldn’t you then create a customized benchmark that represents the composition of your portfolio to see if you are, indeed, “beating the market?”

Of course, the historical track record of active mutual fund managers, who certainly have greater research capabilities than individual investors, illustrates the futility of trying to outperform the market. During the prolonged market volatility of the early 2000s and the global financial crisis, many active managers failed to live up to expectations to outperform in a down market. Then, in the subsequent rising market, although domestic equity benchmarks posted double digit gains, the majority of active managers still lagged their benchmarks.

In recent years, investors have expressed their views on the value of market-beating returns through their investment choices. Over the ten years ended 2013, cash flows into mutual funds heavily favored broad-based index funds and ETFs, rather than higher-cost actively managed funds (Kinniry, Bennyhoff, and Zilbering, 2013). In essence, investors have chosen investments that are generally structured to match their benchmark’s return, less management fees.

Passive assets are on the rise. According to Morningstar Direct, passive assets, as a percentage of total mutual fund industry assets, have risen from approximately 10% in 2001 to more than 28% today. However, remember that the first index fund wasn’t launched until 1971. That means active mutual funds, introduced in the United States in the 1920s, had nearly a 50-year head start. So, yes, actively-managed funds still account for roughly three quarters of the market, but passive funds continue to gain significant market share.

And that’s encouraging individual investors to come around to an approach to measuring performance that we have long embraced. Rather than seek to outperform an index, why not measure your ability to reach your individual goals? And it’s here, by keeping you on track in all markets, that a trusted advisor can lend valuable expertise and support.

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