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9 Common Mistakes Investors Can Make With Benchmarks

9 Common Mistakes Investors Can Make With Benchmarks

May 02, 2024

When investors use benchmarks to track how well their investments are doing, it helps them see if their portfolio is keeping up with the general market or specific sectors. However, there are some common mistakes to watch out for that could make these benchmarks less useful:

  1. Choosing the Wrong Benchmark: It's crucial to pick a benchmark that reflects your actual investments. For example, using a U.S. market index like the S&P 500 to judge a global investment portfolio might not give you the full picture.

  2. Ignoring Differences in Risk: If your investments are riskier or safer than the benchmark, it might lead to misleading comparisons. More risk can mean higher returns, but that doesn’t always mean your investment strategy is better.

  3. Not Considering Fees: Returns often get reported before deducting any fees. Comparing these gross returns to benchmarks that also don’t include fees can distort how well your investments are truly doing. Always look at net returns, which consider fees, to get a clearer view.

  4. Changing Benchmarks Too Often: Some might switch benchmarks frequently to make their portfolio appear better. This practice, known as "benchmark chasing," can hide the real long-term performance of your investments.

  5. Using Inappropriate Benchmarks: If your benchmark is too broad or too narrow, it may not accurately reflect your portfolio’s focus. A very broad benchmark might mask areas where you're not doing well, and a very narrow one might miss the big picture if your investments are spread across many areas.

  6. Overlooking Dividends: Not all benchmarks account for dividends the same way. Some reinvest dividends, which can significantly affect total returns. Make sure you know how your benchmark treats dividends and compare appropriately.

  7. Relying Only on Benchmarks: While benchmarks are helpful, they don’t tell you everything. It’s also important to look at absolute returns, whether your investments are meeting your personal financial goals, how volatile they are, and if they match your comfort with risk.

  8. Emotional Benchmarking: Sometimes, investors might pick a high-performing benchmark with the expectation that their investments should perform similarly. This can set you up for disappointment if those expectations aren’t met.

  9. Not Adjusting to Changes: Economic, regulatory, and market changes can all affect a benchmark's relevance. It’s a good idea to periodically check and adjust your benchmarks to make sure they still make sense for your current situation.

To steer clear of these pitfalls, choose benchmarks that align well with your investment style, what you’re actually investing in, and your risk tolerance. Regular reviews of your benchmarks’ relevance can also ensure your investment strategy remains sound.

I'll write about some of these mistakes in more detail in future blogs.

S&P 500 – A capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing. Past Performance does not guarantee future results.