Wednesday 28 March 2012

What Is Your Benchmark?

How do you judge if your investing strategy is working? What do you compare your performance against - what is your benchmark?

If you are a DIY Income Investor, there are several possible answers...

There are two aspects to total returns: capital value (i.e. based on the current market price of the security) and annual return or yield. Personally, I track total returns in my investment spreadsheet (because I'm too lazy to keep track of individual dividend payments) but I also calculate separately the (notional) income from my investments - on a historic basis - and keep track of the current yield on savings and securities.

Evaluation Period

In theory, it is possible to identify benchmarks that would apply to all investment strategies, although there may be a question over the evaluation period. Academic research into investing often analyses data on returns over very long periods (usually showing that shares beat bonds and cash - although not necessarily for all time periods).

However, most investors will have a shorter term horizon, typically a year. This is actually very short term when looking at stock market investments, given the economic cycles that periodically occur - but let's stick with that 12 month period. Take your pick of financial year, calendar year or year-to-date.

Benchmark 1: Inflation Rate

A starting point for most investors is probably the desire to gain real, absolute total returns - in other words, that your investment capital plus the income from it is worth more, after inflation, this year compared with last year. If you are not keeping up with inflation, you are getting poorer. In the UK we have a choice of official inflation rate: CPI (3.4%) or RPI (3.7%) - take your pick. There is a strong downward trend; UK inflation was over 5% recently.

Benchmark 2: Yield on Cash

Would you be better off leaving the money in the bank (in a high-yield bond or money market account, of course)? A few years ago it was possible to obtain a 7% return by saving into a 'regular saver' account and some similar deals crop up occasionally. Currently my highest-paying long-term savings bond yields 5.05%.

Benchmark 3: Yield on Government Bonds (Gilts)

Why knock yourself out trying to invest when you can pick up (almost) risk-free returns from government stock. Well, the yield is not great. In the UK 10-year Gilts are currently yielding 3.5%, with the return of your money guaranteed. Undated Gilts (e.g. Consols) are yielding over 4% - but there is no guarantee that you will get back what you pay for them (although if you judge the market correctly you may even get more back!).

Benchmark 4: General Market Index

Why not give up trying to beat the market and use a 'tracker'? Most investors recognise that the stock market can behave a bit like the tide coming in - it raises all boats. So it is pragmatic to keep an eye on what the wider market is doing: your increased capital values might just be a feature of a cyclical market trend. So the market return - say the FTSE, S&P or other market index is a useful benchmark.

The iShares FTSE 100 (ISF) is showing a total year-to-date return of 6.29%; however the iShares FTSE 250 (MIDD) has leapt ahead and is showing a total year-to-date return of 16.5%.

Morningstar feature a wide range of US and World indices.

Benchmark 5: General Market Dividend Yield

The average yield offered by the wider market is a useful benchmark of risk. Anything that offers double the market dividend yield is likely to be a risky investment. Currently the yields are: FTSE100 - 3.3%; FTSE350 - 3.3%; FTSE All-Share - 3.5%.

Benchmark 6: Specialised Market Index

Given the DIY Income Investor emphasis on dividend shares and corporate bonds, a better benchmark might be one of the index trackers that includes these features.

The iShares FTSE UK Dividend Plus (IUKD) has a year-to-date total return of 11.43%. By contrast, the iShares Markit iBoxx £ Corporate Bond (SLXX) has a year-to-date total return of only 2.2%.

How Has My Portfolio Performed?

Over the year-to-date - which is very nearly the 2011/12 Financial Yearmy portfolio total return is around 8% and the portfolio yield is 5-6%. Not bad  - I didn't lose money and I kept up with inflation. However, I seem to have missed a big jump in value in the FTSE mid-caps and the FTSE high-yield dividend shares.

Oh well, the next problem will be where to invest the next round of ISA contributions next month.

Do you have any tips on how to measure performance?

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.


  1. my benchmark is more cash in my pocket each month.

    1. Yeadonstar - yes, income is a good benchmark but don't forget you can shred up your capital for income - many so-called 'income' funds do this.

  2. The benchmark has to be focused on the long-term, for example over 10 years. The best benchmark is a 60/40 split between global equities and global bonds, rebalnced yearly.

    1. Farmland - I'm not sure; that is a pretty random benchmark for an income investor. But I agree with the need to take a longer term perspective. I'll need to think about how to implement that!

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