Finding the Benchmark That’s Right for You

To gauge the performance of their investments, investors often turn to the Standard & Poor’s 500 (S&P) Index. But the S&P isn’t the only benchmark of investment performance.

Widely used as a benchmark for the performance of equities, the S&P is designed to be a broad indicator of stock price movement. It consists of 500 leading companies in major industries chosen to represent the American economy.

S&P limitations

But the S&P has limitations. There are more than 5,000 stocks listed on the New York Stock Exchange, and the S&P only tracks a small percentage of them. In addition, the S&P comprises essentially one asset class: large-capitalization companies.

But what if your portfolio comprises primarily small-cap stocks and international stocks? In that case, the S&P may not be the best benchmark.

Other benchmarks

Fortunately, there are other benchmarks. If you invest in a mutual fund, your prospectus and quarterly reporting materials will likely indicate which your fund manager uses. An emerging-markets fund, for example, might use the MSCI Emerging Markets Index; a bond fund might use the Bloomberg Barclays U.S. Aggregate Index.

But even if you are looking at the appropriate index, there are nuances you may not be aware of. For example, some indices aren’t equally weighted. Often, the largest and most popular stocks are weighted several hundred times that of less popular stocks, and the performance of these larger stocks may skew the entire index. In a bull market year, for example, the strength of a few popular stocks can boost the S&P’s return significantly.

Gain perspective on indices

That doesn’t mean you should ignore the S&P and other widely used indices. But do ensure you find the right index for your portfolio, and understand that differences in performance may be explained by differences in your fund’s composition compared with the index. Your advisor can help clarify this for you.

You Need Both Value and Growth Stocks in Your Portfolio

Growth stocks and value stocks tend to take turns leading the market, and as a result investors often raise the question of which of these two types of stocks is really “better.”

While both share a similar long-term, disciplined approach to investing, they are different, and advocates of the two investment styles go about their business in fundamentally different ways.

Growth stocks are those of successful companies with the potential to sustain growth over the long term. In searching for these stocks, analysts look for firms with healthy profits, rising sales, and solid balance sheets.

Value stocks are those of financially solid companies that may be “on sale” due to temporary, non-fundamental reasons. In searching for these stocks, analysts look for situations in which all the good news is not yet reflected in the stock’s price.

Value and growth are typically countercyclical, outperforming during different phases of an economic cycle. In a struggling economy, and during the early stages of recovery, value stocks have historically outperformed growth stocks; late in the recovery cycle, growth stocks have typically dominated.

In the late 1990s, for example, growth stocks dominated the market and value stocks were overlooked. In March 2000, however, the bubble burst, and value stocks started outperforming. We saw a similar dynamic during the great financial crisis that occurred around 2008.

So it actually isn’t a question of which is “better” – you’ll likely want both in your portfolio. Just as diversification between stocks and bonds is important, it’s also important to diversify by type of stock.