Compare Apples To Apples

August 9, 2013
by Michelle Perry Higgins

Start Shopping for Long-Term-Care Insurance at 45What investing term or concept do you think people don’t understand – and what are the consequences?

One word: Indexes. If I were to ask an investor what index they use to benchmark their portfolio performance, the correct answer would be “several.” It’s a mistake to use just one index to benchmark performance of a well-diversified portfolio. My advice is to use at least a handful based on the funds you are analyzing within your portfolio. Unfortunately, I don’t think this is the common answer among investors. I believe there is truly a serious disconnect between their understanding of portfolio investments and the appropriate indexes to benchmark fund performances. Often times, the Dow Jones Industrial Average or the S&P 500 are the go-to indexes because they are widely published. It’s easy to take a quick peek at those indexes to gauge the day’s movement and then view your account. However, investors may not be comparing apples to apples, thus putting them at a great disadvantage in understanding their investments’ performance. This may also mean possibly making moves within a portfolio based on the wrong analysis.  For example, comparing your international funds to the S&P 500 is not a prudent move.

I strongly recommend that every investor take the time to understand what indexes they should be tracking to benchmark their investments. If they have a well-diversified portfolio, this should require more than just the Dow Jones Industrial Average or the S&P 500.