Is your investment strategy delivering the results you expect? The answer also depends on what you compare your investments against and how you interpret that comparison.

Returns Alone Do Not Tell the Whole Story

Your portfolio returned 8% over the year. If a comparable market rose by 3%, you outperformed it by five percentage points. But if it gained 15%, you lagged behind by seven percentage points. The same return can therefore tell a very different story. Without an appropriate comparison, it is difficult to judge whether the result reflects the success of your decisions or primarily favourable market conditions.

What Is a Portfolio Benchmark?

This point of comparison is called a benchmark. It is usually a market index or a combination of indices against which you assess your portfolio’s performance. In active investing, it helps evaluate the contribution of your own decisions, while an index-tracking strategy uses it to show how closely it follows the index. However, it is useful only when it matches your investment focus (if you are interested in how the indices tracked by ETFs are constructed and how they work, you can learn more in our previous article).

Choose Based on What You Invest In

Asset class, geographical and sector exposure, and company size all matter. For bonds, maturity, sensitivity to interest rates, and the risk of the issuer failing to meet its obligations are also important. A global equity portfolio therefore cannot be assessed adequately using only the S&P 500, which tracks large US companies. Underperforming this index may reflect weaker performance in other regions rather than necessarily poorer investment selection.

A Mixed Portfolio Needs a Blended Benchmark

If you hold both equities and bonds, your benchmark should reflect both components. A strategy consisting of 60% equities and 40% bonds corresponds to a combination of suitable indices in the same proportions. If equities rise by 10% and bonds by 2%, the benchmark will return 6.8% at these initial weights, assuming no rebalancing during the period. Rules for restoring the target allocation, such as once a year, should also be established in advance.

Compare Returns on the Same Basis

Both results must cover the same period and be expressed in the same currency. Dividends matter too: a price index excludes them, while a total return index assumes they are reinvested. Also account for differences in fees and taxation, since an index’s return generally does not equal an investor’s net return. Deposits and withdrawals are not investment gains or losses either. A time-weighted return, which removes their impact, is therefore commonly used when comparing a strategy’s performance.

Higher Returns Can Also Mean Higher Risk

The path a portfolio takes to achieve its result matters too. Volatility measures fluctuations in returns, while maximum drawdown represents the largest decline in value from a previous peak to a subsequent trough during the period under review. Outperforming a benchmark while experiencing substantially deeper declines should therefore be assessed with caution. Higher returns may stem from concentration in a few stocks or from financial leverage, which magnifies both gains and losses, and do not necessarily demonstrate a better strategy (fluctuations in value are not the only investment risk, however. We explore other risks worth understanding in our previous article).

Short-Term Underperformance Does Not Necessarily Mean Failure

Different strategies excel under different conditions, so a single month or year is not enough to draw a reliable conclusion. Review several periods that include both rising and falling markets. Temporary underperformance may be consistent with the strategy’s characteristics, but repeated weak results warrant a review of costs and investment decisions. Choose your benchmark in advance and do not change it retrospectively to whichever makes your portfolio look better. Any change should be justified by a genuine adjustment to your investment focus.

A Benchmark Is a Tool; Your Personal Goal Remains the Priority

Beating the market does not guarantee that you will save enough for a home or retirement in time. Reaching the required amount also depends on your contributions, investment horizon, and inflation. Monitor both your performance against the benchmark and your progress towards your own goal. A benchmark should help you evaluate your strategy, not encourage unnecessary risk-taking. What matters is whether investing brings you closer to meeting your financial needs at a level of risk you can tolerate over the long term.

For more investment trends and useful tips, explore our previous articles on AxilAcademy.