You should review your portfolio periodically.
But what should you look for?
Portfolio performance is one key area. Both income and capital gains.
To assess performance, a benchmark to compare your results is required.
What is a Benchmark?
A benchmark is any figure against which you use to measure your portfolio’s performance.
The chosen benchmark can be a variety of figures. Or it can be a combination of multiple factors. We will review some common benchmarks later.
Keys to a Good Benchmark
The benchmark should accurately reflect your portfolio and personal circumstances.
Relating to the portfolio, the benchmark should reflect the type of portfolio holdings, the management style, portfolio risk, etc.
Personal circumstances may include investor objectives and constraints, risk tolerance, accumulated wealth, life cycle phase, time horizon, etc.
From a technical perspective, a good benchmark should have readily available data. You can determine the best benchmark in the world, but if you cannot access historic data on a timely basis, it will be of little use.
I think the prime consideration is that the benchmark reflects the risk-return profile of the portfolio. You always want to compare apples to apples, not to oranges.
Selecting a Benchmark
Select a benchmark concurrently with your actual portfolio construction.
It makes no sense to try and identify a relevant benchmark after the fact or during the period. Choose a target at the start of the period and stick with it throughout the time horizon.
Try to maintain the benchmark for a reasonable period. If your personal circumstances change, or you materially alter the composition of your portfolio, then the benchmark should be reassessed. But do not change continuously. If you do, the quality of information you get from comparisons between benchmark and actual returns will be poor.
There are a variety of of benchmarks available or that can be created. Some are quite simplistic, others are extremely complex. The greater the complexity, the greater the amount of work usually required to maintain.
Over the next couple of posts, we will look at some common benchmarks. I will also provide some suggestions on developing benchmarks that provide quality information, yet do not require too much work.