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.