Comparing Market Returns and Your 401k
Photo Credit dflorian1980
It’s a new year. With 2012 underway, many of you have received retirement account statements or a notice to view your information online. (If you haven’t yet, you will soon.)
This provides the perfect opportunity to spend some time examining your investment strategy, and make sure you’re on track to reach your goals. This is also a good time to review appropriate benchmarks to see how your investments stack up.
But finding that appropriate benchmark seems to bring about confusion. Some turn to ‘The Market’ to compare their investments. But what does that really mean? There’s typically a big difference between ‘The Market’ and someone’s diversified portfolio.
Your portfolio and the market
The term market tends to be thrown around loosely by various media outlets, which can lead to confusion and misinterpretation. So let’s look at the two most common measures of the U.S. stock market for 2011:
- The S&P 500 Index was essentially flat on the year, with a fractional downside move of less than 0.01%.(finance.yahoo.com, 12/30/11)
- The Dow Jones Industrial Average was up 5.5%.(finance.yahoo.com, 12/30/11)
The indexes above are the most commonly cited indicators of market performance in the U.S., but it’s important for investors to realize the difference between indexes and personal account performance.
- The S&P 500 is an index that tracks the stock prices of 500 large-cap U.S. companies from various sectors of the economy.
- The Dow Jones Industrial Average (or just Dow to save time) is a price-weighted index that tracks the performance of 30 of the largest U.S. stocks. The Dow 30 are mainly industry-leading companies with large market caps and a history of stable earnings.
It’s important for investors to realize that comparing the performance of your own investments with a market index like the S&P 500 or the Dow is like comparing apples with oranges – or even more like comparing apples with fruit salad. As stated above, both indexes reflect the performance of only one asset class – large-cap U.S. stocks.
However, if you’re a diversified investor with an investment plan intended to stay in-line with your personal goals and risk tolerance, your portfolio could hold investments from additional asset classes, like small-/mid-cap companies, bonds, international stocks and cash. If you’re looking to use benchmarks as a way of tracking the performance of your investments, one suggestion would be to create your own portfolio of benchmarks that matches your mix of personal investments. For example:
Your Portfolio Suggested Benchmark Portfolio
20% Bonds 20% Barclays Capital US Aggregate Bond Index
15% International Stocks 15% MSCI EAFE Index
5% Cash 5% US Treasury T-Bill Auction 3-month
60% Large Caps 60% S&P 500 Index
The performance information for the above listed benchmarks can be obtained using market data sites like Morningstar.com. There are also a number of Target Risk Indexes available to compare with on Morningstar’s website using your own personal risk level. However, a benchmark will never perfectly reflect your personal asset allocation and your own account’s performance since there are so many other factors involved.
The purpose of diversification is to minimize volatility and reduce risk by holding investments from different asset classes since each asset class will behave differently in particular market conditions.
Market volatility can bring short-term periods of outperformance and underperformance, and a diversified portfolio won’t look exactly like the indexes.
Here is an example: If you’re a diversified investor with your money spread across multiple asset classes according to your risk level, you are protecting yourself from the risk associated with a decline in any one category. If 20% of your portfolio is an asset class that suddenly declines 5%, only that small portion of your account will decline by that 5%. At the same time another category may have performed fairly well recently, which may completely offset that 5% decline. Thus, showing the advantage of diversification.
This isn’t to say you shouldn’t compare your investment results to a benchmark, quite the opposite. You should absolutely track performance. But take care to choose the right comparisons so you’re making informed decisions. Make sure you understand what your asset class allocation is and why you’re invested in that manner (e.g., your time until retirement, your desire to keep risk to a minimum, etc). Then find the right benchmarks for your asset mix. There could be several to track, but you’ll have a better idea how your investments compare.
If you want to talk about your portfolio allocation or learn more about the benchmarks most appropriate for your account, contact the Smart401k team at 877.627.8401.
Andrew Thomas
Smart401k Associate Representative
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Smart401k is a web-based investment advisory service providing unbiased recommendations to help people invest in employer-sponsored retirement plans. Smart401k provides service to nearly 11,000 clients who collectively have more than $2 billion in assets. Plan participants receive personalized, fund-specific investment recommendations and the support of professional investment advisers available to discuss all investment questions. Based in Overland Park, KS, Smart401k is online at www.Smart401k.com.
