WHY BENCHMARK
In investing, a benchmark is something against which an investor can measure returns. It provides a yardstick, often to determine whether an active investment strategy is outperforming a passive strategy. Clearly, if a passive approach can’t beat an active one, then why bother with the active one? The same logic extends to hiring an investment advisor; if he/she can’t beat the specific benchmark, then why is it worth it to pay him/her for inferior returns? Also, mutual funds are actively managed, so if they aren’t beating a similar, passive index, why pay those embedded management and other fees?
I manage 100% of my investments, and I will keep doing so as long as I am outperforming. Even if I don’t outperform for a year or two, I will continue to manage my investments because I believe that I will outperform in the long-run. If I’m not able to outperform in the long-run, then I am better off utilizing a passive approach.
WHAT BENCHMARK
For me, a passive approach would entail investing in the S&P 500, which is a close enough approximation of the U.S. stock market. If I wanted to put my investments on autopilot for 10 years, I’d just buy the S&P 500 index. I understand that there are other passive approaches; for instance, some investors want exposure to small cap equities or foreign investments. That’s fine, and perhaps those investors would choose a different benchmark or even a blend of multiple benchmarks. But for me, I want to measure whether my active, concentrated, high growth strategy is beating the overall market, and, thus, I’ve decided that the S&P 500 index is the best benchmark for me.
S&P 500 TOTAL RETURN
Unlike my high growth stocks, the S&P 500 index contains many companies that pay dividends. It would not be a fair comparison if my benchmark excluded dividends as they are part of the investment returns. I’ve noticed that many investors benchmark their returns against the S&P 500 index (e.g. ^GSPC on Yahoo! Finance) that doesn’t include dividends. It’s really an unfair comparison because they’re excluding a very real part of the return of the many S&P 500 component companies. In contrast, I use the S&P 500 Total Return Index (i.e. ^SP500TR on Yahoo! Finance) because it includes the total return, including dividends. Below is a five-year chart comparing the ^SP500TR to the ^GSPC.
EXAMPLE OF BENCHMARK USAGE
The table shows the GauchoRIco Portfolio benchmarked against the S&P 500 Total Return. I’ve also included the S&P 500 Index (without dividends) just for comparison. The comparison spans 2017 through 3Sep 2021.
| YEAR | GR PORT RETURN | GR PORT CUMULATIVE RETURN | ^SP500TR RETURN | ^SP500TR CUMULATIVE RETURN | ^GSPC RETURN | ^GSPC CUMULATIVE RETURN |
|---|---|---|---|---|---|---|
| 2017 | +61.6% | +61.6% | 21.83% | 21.83% | 19.42% | 19.42% |
| 2018 | +55.9% | +152.0% | -4.38% | 16.49% | -6.24% | 11.97% |
| 2019 | +41.8% | +257.3% | 31.49% | 53.17% | 28.88% | 44.31% |
| 2020 | +245.6% | +1134.7% | 18.40% | 81.35% | 16.26% | 67.77% |
| 2021* | +79.2% | +2112.8% | 21.95% | 121.16% | 20.75% | 102.58% |
If we compare the Compound Average Growth Rates (CAGRs) over the entire 4.6767 years (note: I recently wrote a post about CAGR and how to calculate it), then we can get a better idea how much the ^GSPC is underestimating the true return of the S&P 500 Index. The ^GSPC’s CAGR was 16.29% while the ^SP500TR’s CAGR was 18.50%. Thus, the ^GSPC underestimated the S&P 500’s return by 2.21% per year over the period from 2017 through 3Sep 2021. The GauchoRico Portfolio produced a CAGR of 93.9% over the same period; thus the GauchoRico Portfolio outperformed the benchmark by an average of 75.4% per year. If I had used ^GSPC as the benchmark, my returns relative to the S&P 500 would have been overestimated by 2.21% per year.
The opinions, thoughts, analyses, stock selections, portfolio allocations, and other content is freely shared by GauchoRico. This information should not be taken as recommendations or advice. GauchoRico does not make recommendations and does not offer financial advice. Each person/investor is responsible for making and owning their own decisions, financial and otherwise.