About using benchmark portfolios to compare investment performance.

About Investment Benchmark Portfolios and Benchmarking

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Before the long-winded explanation, there's an investment software product so anyone with investment data can perform their own detailed investment vehicle and/or portfolio benchmarking, comparisons, and analysis.

It comes with the Investment Comparator product (so click to see ordering info).

Download the demo

One of the services described below is about hiring us to input your data into this program (because we have it, and you probably don't). Investment data comes from vendors like Morningstar, so it's both very expensive and extremely difficult to use.

It comes with the Portfolio Statistics Calculators, which used to be part of the Asset Allocation Software:

Portfolio Statistics Calculators

This is a very scaled-down version of most portfolio optimizers / analytics software selling for over $1,000. It displays:

• The custom reference asset's: Beta, Alpha (Jensen), R-squared, Treynor Ratio, and Sharpe Ratios.

The reference used for these comparisons can be any of the four benchmarks (S&P 500, Barclays & S&P US Aggregate Bond, MSCI EAFE, or even a custom benchmark that you would manually input).

• Statistics from a user-defined benchmark index. This allows you to compare the custom reference asset to anything you want.

The custom benchmark index, and/or the custom reference asset, can be one investment or a portfolio of hundreds.

This allows you to input investments to see how they've moved compared to the major asset classes (or the custom benchmark) over selected time frames. This helps decide whether or not adding the investment will make a portfolio perform better or worse (AKA more efficient or optimized). If it has low correlations and good returns, then adding the investment will reduce the portfolio's overall risk and probably increase returns at the same time.

• Correlation coefficients (r) of the reference asset compared to the S&P 500, Barclays & S&P US Aggregate Bond Index, the MSCI EAFE Int'l stock index, and your custom benchmark index.

Calculating these numbers was the main reason for building the sheet - to let you input investments and see how they've moved compared to the major asset classes over time frames that you can select (on a quarterly basis going back to 1976).

• Average / Median / Minimum / Maximum rates of return and standard deviation over the selected time frame.

• Growth of any amount of money over the selected time frame. This displays similar chart information as the old Ibbotson charts showing "Growth of $10,000" since a very long time ago.

It's updated monthly for the S&P 500, Barclays & S&P US Aggregate Bond Index, MSCI EAFE Int'l stock index, our Moderate Fee-Based Model, and our Moderate Model funded with benchmark indices.

• Our Moderate Asset Allocation Model's monthly returns (since inception of January 1999) are input into the Reference Asset's input area. This is so you can see the portfolio statistics of a portfolio that's being used in the Real World.

Then the same Moderate Model funded with appropriate benchmark indices is input into the Custom Benchmark area. This shows an example of allowing the proper calculation of portfolio statistics, like alpha.

You would delete these returns and then input your own data for portfolios, or assets, that you're evaluating.

What is Portfolio Benchmarking?

Benchmark portfolios are also known as null portfolios, normal portfolios, comparison portfolios, proxy portfolios, market proxies, benchmark indices, index benchmarks, composite benchmarks, and target portfolios. There are technical differences, but they're usually all the same thing.

This term was first coined back in the olden days. So far back, the original source can't be cited.

We mention the elusive "proper benchmark index" on other pages, but have yet to define it. So here's an analogy to help condense it into a nutshell:

Assume you want to see how well your training is going in the sport of jumping (where you launch with both feet on the ground to get as far away from that spot as you can).

Also assume there's a thirty-foot bench in the park you’re training at. So you decide to set your starting point at one end of the bench.

After a while, you'll know what your average jump distance is on an average day at noon wearing your favorite shoes.

So you pick up a rock and scrape a mark on the bench to mark this distance.

Now you have a standardized point of reference to work with, by putting a mark on the bench (that's really all there is to it).

About investment benchmarking for performance comparisons.

Now you want to see if things you're doing to improve your training will help or hurt this performance standard. So you try different things, and see how the actual results compare to the mark on the bench (the bench mark).

For example, you want to try wearing a different pair of shoes. In our world, this would be replacing a benchmark index, like the Russell 1000 Growth Index, with an actual large-cap growth mutual fund. If the mutual fund (new shoes) beat the index (old shoes), then we've found a way to realize better investment performance for investors and advisers.

Your favorite pair of shoes got you the benchmark distance (the market, or index fund), the different pair of shoes got you an inch before the benchmark (ETFs), and the other pair of newfangled sport shoes got you two inches past your benchmark (well-screened mutual funds).

Now you know wearing which pair of shoes resulted in the best jumping performance (the sports shoes).

The point is to set up a proper baseline point of reference, that can't be altered by extraneous events, so you can make precise and measureable comparisons; when you manually alter other factors that go into achieving the end result.

Proper is the key word, because once you set something up, you cannot do anything to contaminate the point of reference.

For example, if you skipped breakfast (making it not a normal average day) before you tried a new pair of shoes, and you came up short; then it was probably the fact that you were out of gas that led to your poor performance, and not the new shoes. Skipping breakfast contaminated the benchmarking process, thus making it "improper."

In investment management, one always needs to keep everything proper in order to precisely measure, and then calculate, the difference between the two sets of factors that are being compared (AKA delta from the benchmark).

In investing, there is usually a viable benchmark index that can be used as a baseline for making these types of performance comparisons. But sometimes, there's not.

For example, it's relatively easy for Russell to maintain their 1000 Growth Index. All they need to do is monitor all US large-cap growth stocks, sort them by market capitalization, and then report data on just those 1,000 stocks; starting with the largest, down to the 1,000th largest.

But try to find a decent benchmark for US micro-cap stocks. You'll find that most are "improper." You'd have to ask the benchmark creators and maintainers why they're so "lame" when it comes to this sector. A guess is that they're just not getting paid enough to accurately maintain it.

This is probably because stocks with market capitalizations this small tend to either go under, get bought out, merge, return to private hands, too many new firms go public too quickly, and/or they quickly grow into becoming small-cap stocks (which moves them from one asset classification into a different asset class).

So it's probably just too much work for too little money for them to profit from. So there has never been a decent benchmark index for micro-cap stocks, and there probably never will be.

To be proper when comparing whole investment portfolios, the mix of benchmark indices needs to called something appropriate, have the exact asset classes and weightings, the fees and rebalancings have to be the same, the time frame has to be the same, all security trades need to be the same, and cash flows have to all be the same.

Basically everything has to be the same other than just the ONE factor that you're changing, using, modeling, or testing.

The name for this is usually a benchmark model, model benchmark, or just "the shell."

So when investment portfolio benchmarks are set up properly, the only thing that usually changes is an index fund that represents its market and asset class, is substituted for an actual investment the manager held in the Real World.

Usually the purpose of doing this type of work is to see if an active investment strategy (after fees and expenses) outperformed a passive investment strategy.

First, the active investment strategy is usually constructed using a computerized model with the historical returns of the actual investments held.

Then everything in the model is held the same, except all of the actual investments are swapped out and replaced by the benchmark index, or index mutual fund or ETF, that best represents each asset class. Then the results are compared.

If the benchmark index fund model did better, then the money manager that picked the actual funding vehicles did not do a good job (because one could have just used index funds to realize better overall investment returns - most likely all with less risk and less expenses).

If it did worse, then the money manager did a good job of security selection, and earned their money paid to them for selecting well-performing ETFs, stocks, or mutual funds.

For example, say one of the investments used in the active model was GM stock. When it comes to choosing the proper asset class index to benchmark against it, one would find and use a US large-cap value index (e.g., Russell 1000 Value), and not a small-cap growth index (e.g., Russell 2000).

You see benchmarking used constantly in the investment industry because most everything boils down to how something performed compared to something else.

That something else is usually an index comprised of most all securities of the same type (asset class, or the aggregate returns of all similar mutual funds in an asset class).

Benchmarking is just the process of how it all gets done.

It's impossible to manage what you can't measure.

Benchmarking is the process that appropriately compares, and then allows one to measure, difference in investment performance (and then its relevant statistics, like alpha).

One uses custom benchmark portfolios to compare the performance of actual (client) portfolios to an identical portfolio comprised of benchmark indices.

To be identical, and thus properly comparable, they have to have the same asset classes, weights (percentage held), and time frames, as the actual portfolio. In other words, a "shell" that is identical to the actual portfolio is created, and then funded with indices.

The difference in returns is the value added (or lost) due to "active management."

If the actual portfolio made more money than the benchmark portfolio, then the investment manager that actively chose the funding investment vehicles provided that difference in value, because they picked securities that made more money than just the index. In other words, their security selection techniques added value.

If it didn't, then the manager did not add value, and the investor would have been better off just funding the asset allocation mix with index funds (or index-like ETFs).

Funding a buy and hold asset allocation with index funds or index ETFs is called a "passive management" strategy.

Active management is arcane jargon that means someone is actively managing the portfolio by implementing one, or a combination of, the three ways to manage money.

This is in contrast to passive management, which typically means just holding a constant mix of indices (although if you use more than one asset class, then you're using asset allocation by default).

An alternative to this arduous process is to compare actual portfolios made up of different asset classes (cash, bonds, int'l, real estate, technology, etc.) to just a single market index (e.g., the S&P 500).

It should be obvious (to professional advisors) that comparing a portfolio comprised of different asset classes to just the S&P 500 is incorrect.

This is because you want to compare things apples-to-apples, and there are oranges and all kinds of other fruit in the actual portfolio.

It would only be correct to compare a portfolio of about 60% large- and mid-cap growth stocks and about 40% large- and mid-cap value stocks to the S&P 500 (because that's what the S&P 500 basically is comprised of).

Another commonly-used alternative to this method of benchmarking, is to use mutual fund universe asset class averages, like those contained in database programs like Morningstar. This is just averaging most-to-all similar assets that are contained in the database's universe together.

For example, if you did that in Morningstar for large-cap growth using their mutual fund database, then it would just sum up all of the mutual funds in that universe together that are flagged with the Morningstar Category of large-cap growth, and then calculate, and then display, these averages.

These are helpful, but have many fundamental problems, for example, survivorship bias. This is when a mutual fund goes under, it drops out of the database, which upwardly biases the average returns after it's gone. Other problems are very limited asset class data, and there's too many mutual funds with inceptions not long enough for the time frame you're interested in. Then it's just cumbersome and hard to use.

In a nutshell, we provide services that can create this elusive proper benchmark shell, for just about anything advisors, or investors, use as their investment strategy. Basically, just feed us a few bucks, and then we'll tell you how you did.

With these benchmarking services we offer, you can choose from these different methods, and also pick most any monthly time frame you want. For example, if you maintain a Model Portfolio and your fiscal year ends in August, then you'd probably want data to show at least the one-year, three-year, and five-year returns, starting on 1 September.

Creating benchmark portfolios is the correct and professional way to compare things like investing strategies and tactics.

But you don't see it used much because professionals would have to first figure it all out, then shop for investment database software (there's really only one program that gives good data with all of the asset classes over adequate time frames), then spend ~$1,000 to buy it, then learn how to use it, then actually sit at the computer and do it, work out the bugs, and then update everything when needed. This takes a lot of hard, tedious, and boring brain and computer work.

Then most wouldn't want to show the results to clients, because it puts the spotlight directly on their performance.

It's extremely hard to consistently beat the indices, so they'd get beat up by clients, and then have to waste time answering too many questions. They'd rather be on the phone managing relationships than being a computer nerd, so they just don't do that. It's much easier to let sleeping dogs lie than to open a huge can of worms and start a battle they probably won't win.

If you're a financial planner managing money for clients, and you're pretty sure what you're doing is adding value over a passive strategy, then this is a great way to prove you're earning your keep (and why you're better than your competition, which statistics show is the #1 criteria investors use in retaining money managers).

If you're not sure how well you're really doing - then this process will tell you.

You can see how well our Fee-Based Aggressive Model Portfolio (or the Fee-Based Moderate Model Portfolio when markets are down) has performed compared to its proper benchmark model, in just about every time frame, by looking at the table of historical returns here. The second row has the returns for the actual model. The third row has the returns for the exact same model funded with benchmark indices. The forth row displays these bottom-line comparison numbers.

Then you can download either the demo for the Portfolio Benchmarker Software, and look at the second to far right sheet tab (named Portfolio Statistics), or you can download the Model Portfolios Demo, and look at the same thing screen printed into a Word docx.

This shows all of the usual portfolio statistics that can be generated after the benchmarking process described above has been properly constructed. The number of most interest here is alpha. As you can see, you'll probably never see a higher alpha number anywhere from anyone.

This alpha number quantities the value of our mutual fund screening process (because the only difference between these two models is that one is funded with the current mutual fund picks, and the other, just benchmark indices).

About Benchmarking Services

Getting us to populate the Benchmark Software with your data is $100 per hour. Most of the following text is about not using the existing software, but making customized benchmarkers.

Once you get your benchmarking done, you don't need to show the results to your clients if you don't want to. You can just use it for your own reference. Then you can change investment tactics over time to see what works best for you.

If you're an investor, then this will tell you how you and/or your investment managers are really doing. If they're underperforming, then you may be better off doing it yourself.

If you're interested in having custom portfolio benchmarks created using indices represented by generic asset classes (indices), send e-mail telling exactly what it is you want. It will take a few rounds of question and answer e-mails to provide you with an estimated price and lead time.

Basically, you'd send a portfolio (text is fine - all that's needed is the full name of all of the investments and dollar amounts), and a time frame, and you'll get a custom benchmark portfolio shell comprised of the best available fitting indices for each asset class back, with returns looking back over any time frame (as long as the data goes back).

Then you'd just compare these returns to your actual after-fee investment portfolio returns, and go from there.

The work you'll receive is not protected in any way, so you can reformat, update, and change anything you want to.

All work is confidential and no information is given out to anyone without your permission, period.

Why rack your brains and spend way too much time and money over this? Just let us do it!

If you value your time at $100 per hour, then it's going cost you over $1,000 just to figure out how to do it right. Then that's assuming you already have the $750 a year investment database software needed to do the work. Then you'll have to do the work, fix mistakes, check everything, format, etc. So if you do it yourself, then you're looking at a total price tag of over $3,000 just to do one simple benchmarking job.

We can usually perform this work for you for one tenth to one fifth of that cost.

Warning! Getting custom benchmark portfolios made is a big deal that requires work on our part. So it is not part of the Bundled Deals, or Lifetime Subscription, and could cost well over $1,000.

Also, unless you're very sure that your investment strategy has beaten the indexes, then you'll probably spend time and money just to be disappointed (in yourself). The reason is because it's rare to beat any benchmark. Especially since 2013, when S&P 500 ETFs became the tail wagging the stock market dog.

So if your active investing management strategy beat the passive model, then you'd be the exception to the norm. So far, the only investing strategy we've ever seen to beat its benchmark is ours.

We're just saying that up-front because we don't want you to be mad at us, and feel like you've wasted that time and money paying us for the service. There's a 95% chance that your investment strategy did not beat the benchmark, so please do not shoot us just for being the messenger!

For free sample downloads, right click on a link below, and then choose "Save (Target) As..." to save to a folder on your hard drive. Then open it with MS Word or Excel

Download a newsletter explaining portfolio benchmarks

Download an old benchmark study using VA subaccounts

Download another sample monthly "How's your portfolio doing compared to the benchmarks" newsletter"

Download an example of a benchmark portfolio done for a financial planner's four-model 401(k) allocation. This customer only wanted to use two asset classes, so not doing the job on an apples-to-apples basis skewed the results to make their performance look worse than it really was. It has 44 data points in all, shown in green, so it cost $220 to set up the first time, and then $22 to update

Download a simple example of a benchmark portfolio for investor models

About Our Investment Benchmarking Services

We specialize in performing the most arcane, arduous, difficult, time-consuming, tedious, cumbersome, boring financial work you can think of. We want to do your worst-case benchmarking jobs that nobody else will touch. The more complex the job is, the more we want to do it!

The cost for creating custom benchmark portfolios is $5 per data point

For example, if you have five asset classes, and you want to see results for five time horizons, then the price would be around $125 (5x5x5).

The exact amount won't be known until we start making them. We'll estimate the total price before taking on the job.

Getting data updated from an existing template is only $2 per data point.

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About the Department of Labor's New Fiduciary Rules

Using Asset Allocation to Manage Money

Download Brokerage Data into Spreadsheets

How to Integrate Financial Planning Software Modules to Share Data

CRM and Portfolio Management Software

About Monte Carlo Simulators

About Efficient Frontier Portfolio Optimizers

Calculating Your Investment Risk Tolerance

About Discount Brokers for DIY Money Management

About 401(k) Plan Management

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