My Benchmark For Tracking Dividend Portfolio Performance
- 3 Comment
 |
If you are a do-it-yourself investor who buys individual stocks (i.e. dividend stocks), as many of my readers are, then we are slaves to our investment returns. But how do we know how we are performing. If we earned 12% last year, that may seem like a pretty good return. However, if the overall market provided a return of 22% then you didn’t do so hot. It would have been much better for you to have bought the market through an index fund or ETF. It is therefore important for investors to set up a benchmark that we can compare our performance to to gauge how we are performing. There are few different options for setting up a benchmark – I will provide a couple and then tell you how I do it.
Tracking Against an Established Index
The most common way to compare and evaluate portfolio returns is to put your returns up against that of an established stock market index. The index you can use can be the S&P 500, Dow Jones, Nasdaq, Russell 3000, S&P/TSX, or any other stock market index in the world. The most common index to compare results to is the S&P 500.
For more information on how to track your performance using this type of strategy, please check out Gen X’s article titledUse the Right Benchmark to Accurately Measure Investment Performance.
My biggest concern with this approach is that investors often do not have a portfolio made up of 100% equities. In fact, if you believe that asset allocation is a large determinant in portfolio returns, then you probably shouldn’t. With that in mind, I would argue that it is not prudent to compare the results of a portfolio that is not 100% equities to that of a 100% equity index such as the S&P 500. My approach is a bit different and is based on some research done by Richard Croft of R. N. Croft Financial Group Inc.
Tracking Against an Portfolio Benchmark
Richard Croft has devised a series of portfolio benchmarks that take into account that certain investors have certain asset allocations in their portfolios. They have pegged these benchmarks as FPX Indexes. There are three choices of indexes to use as a benchmark each having a set asset allocation amongst equities, fixed income, and cash:
The FPX Index I track my portfolio to is the FPX Growth as it is the closest one to my actual asset allocation based on my stage in the investing lifecycle and views on portfolio structure. My primary reason for using this as my benchmark is it allows me to compare my overall portfolio and not just one component of it. Again, if I was investing in 100% U.S. equities then I could track my portfolio against the S&P 500. I don’t have 100% equities, so the FPX Growth index provides me with a more realistic snapshot of how I should be doing based on a set asset allocation – and asset allocation provides an investor with 70% of a portfolio’s return!
(Photo Credit: Ruben Joye)
3 Comments on this post
Trackbacks
-
Dividends4Life said:
TDG: I suspect a lot of people use the S&P 500 since it is their alternative to going at it on their own. Since it is easy to invest in, it is their out if they have multiple years of under performance.
Good read, thanks!
D4L
November 10th, 2007 at 9:09 am -
WhereDoesAllMyMoneyGo.com said:
I would add that for those that don’t mind taking a few extra steps it would be best to create your own weighted-average benchmark. While I think Croft’s 3 models are better than just picking a market to compare to, I think it doesn’t go far enough (at all).
For example, I recently set up a portfolio which was:
76% Equities
24% Fixed IncomeBut further to that, the equities were from different markets. The weighted average benchmark actually looked like the following:
36% S&P/TSX Total Return Index
8% S&P500 Total Return Index
20% MSCI EAFE Index
22% MSCI EM Index
24% Scotia Capital Short Term Bond IndexThis reflects the proportion of investments made within each market.
By taking the return of each index and multiplying it by the percentage of the portfolio those investments represent we can get a much more accurate benchmark. For example, if the returns were as follows for a 3 year period:
TSX: 11%
S&P500: 8%
EAFE: 8%
EM: 17%
SC Short Term Bond Index: 4%Then multiplying the returns by the asset weights will give me my custom benchmark:
TSX: 11% Return x 36% Weight = 4%
S&P500: 8% Return x 8% Weight = 0.64%
EAFE: 8% Return x 20% Weight = 1.6%
EM: 17% Return x 22% Weight = 3.74%
SC STBI: 4% Return x 24% Weight = 0.96%Add them all up: 10.94%
So that would be the benchmark against which to compare the portfolio. It doesn’t take much time, and the math is easy.
You can go further as well. If you pick dividend paying stocks, if you wanted to compare their returns to the overall TSX (because you think dividend paying stocks are better than the market) you can do that. If you want to test your ability to pick the BEST dividend paying stocks, then you would use the S&P/TSX 60 as the benchmark for those investments.
Note: I used the short term bond index because for that particular portfolio we setup a 5 year bond ladder with Canadian bonds only.
Also note that you can compare the beta of your portfolio with a known market’s beta, or again against a weighted average beta of the benchmark portfolio.
You would compare your portfolio’s beta against the beta of, say, the TSX to see if you could get a certain percentage of the returns and reduce beta – this might confirm that adding investments from other markets (while by themselves more volatile) would reduce long term risk.
You would compare your portfolio’s beta against the weighted average beta if you wanted to see if the investment picks within each market were less volatile than the markets’ average – to help assess your overall stock picking abilities.
November 11th, 2007 at 5:26 pm
[...] You can read the full story here [...]