Clark Wealth Management Group - ScotiaMcLeod Fredericton

Whether the stock market is going up or down, most investors compare the performance of their portfolio against one of the major ‘market indices’ such as Canada’s S&P/TSX Composite Index. When an investment lags the benchmark it is deemed to have underperformed. All too often, an unnecessary juggling of the portfolio follows.

While market indices can be powerful sources of information for investors, advisors and investment managers alike, they are purely measures designed to give a general snapshot of overall market performance.

In extremely narrow markets, indices like Canada’s S&P/TSX the index performance can be problematic. In Canada, repeatedly throughout history there have been times when a small number of companies or sectors perform well, distorting what’s happening in the broader market. As a result, benchmarks like these do not have the ability to reflect the true performance of a broadly diversified portfolio.

For investors, benchmarks may not be helpful in gauging how well or how poorly, they are doing in meeting their financial goals. While investment performance is important, long-term financial success is more reliant on your individual goals, rather than what "the market" returned.

Major market indices such as the S&P 500 Index, the S&P/TSX Index or the Dow Jones Industrial Average (DJIA) track the performance of a specific basket of stocks considered to represent a particular market or sector of the markets. In reality, the methodology of the index creator carves out a subset of a market. As such, they do not have the ability to capture the true length and breadth of a market. The often referenced DJIA is ridiculously narrow representing a basket of only 30 companies. That’s hardly representative of the broader US market where there are thousands of stocks traded on the various markets.

The majority of indices are market capitalization-weighted, which means that the value changes in proportion to the value of the stocks in the index. In other words, when an index goes up, the collective value of the stocks in the index have grown by a proportional amount, and vice versa. All indices measure the performance of a market or some subclass of them, normally on an ongoing basis throughout each trading day.

By comparing current performance with previous market history, investors can gauge market trends that may influence their investment decisions. The majority of professional investment managers use indices as benchmarks; however, portfolios that are actively managed are rarely limited to investing in only securities in the index. As a result, portfolio holdings and performance could differ from the index.

But do market benchmarks matter for you? Rather than focusing on market benchmarks, the most important indicator of financial success should be whether you are achieving the rate of return necessary to reach your goals.

While tracking investment performance is a critical step in every investment plan, to fairly evaluate your portfolio, you should compare how your investments have performed relative to your unique goals by using the following guidelines:

• The specific market environment for the asset classes that you are invested in;

• The investment climate for the measurement period;

• The performance of other investments in the peer group;

• And the level of risk you have taken to pursue those returns.

As part of the financial planning process, involving all your goals, hopes and dreams, a required return projection is calculated. This is your personal benchmark. This becomes the only benchmark that should matter. It keeps your decisions based on your plan rather than the short-term prevailing market conditions.

Your benchmark is customized, risk-adjusted, grounded in the realities of your unique situation, and can be adjusted throughout your life to account for changes. It makes far more sense than chasing a completely unrelated market index.