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Click here for a link to an Excel spreadsheet (Club_vs_Index.xls) designed for Investment Club benchmarking.

The purpose of benchmarking is to evalute the return that would have been produced by various investment alternatives, if the same amounts of cash were invested at the same times in each alternative.  Benchmarking answers the following question:  "With the amounts of money I had to invest, and considering when I was able to invest them, which of several alternatives would have produced the most money in the end." One reason for doing this is to determine whether or not you have been beating "market" returns. Since "market" returns can be achieved with very little effort on your part (by investing in index funds), some consider "beating the market" to be one of their investment goals.

To say that my investments are up 12% is meaningless without comparing that return to something else.  Saying that my investments are up 12% this year while the S&P is (only) up 7% is also meaningless unless both returns are based on the same amount(s) of money invested at the same time(s).  Time and timing is everything. For bragging rights, one can say, "I'm up 22% in XYZ Co", or "my portfolio has grown 18% so far this year".  However, comparing one's performance to someone else's in that way can be misleading.  The larger return wasn't necessarily the better investment.  If you really want to know which was the better investment, the question to be answered must be, "which set of actions would have produced more money in the end?" 

For most investors, this requires something to compare themselves to on a one-to-one basis.  Typically, the comparator is the Wilshire 5000, exemplified by the Vanguard Total Stock Market Index (VTSMX).  A proper comparison requires the cash moving into and out of the real portfolio and the benchmark portfolio to be the same (in both amount and timing).  Earnings produced in either portfolio (dividends, interest, sale proceeds) must be reinvested within the portfolio.

If a portfolio holds both stocks and bonds, does one use a benchmark such as the S&P 500?  If one wants to be accurate, the answer is no as bonds should not be compared with a stock index.  Further, if the portfolio includes sizable holdings in mid and small-cap stocks, the S&P 500 is inappropriate as it is classified by Morningstar as a large-cap core holding.

To come up with accurate benchmarks, one needs to break the portfolio down into different asset classes and use appropriate benchmarks.  For example, all small-cap value holdings could be compared with the IJS iShare. Complicating this process is the addition or withdrawal of cash from a particular asset class.  This process quickly becomes tedious and this is why most folks interested in benchmarking will revert back a broad index such as the Wilshire 5000 or an investable index such as the VTSMX index.