The importance of an investment benchmark
Updated: Mar 1, 2022
Investing is a personal experience, and so the right benchmark will differ from person to person
Investors should always have a benchmark in mind when they invest.
Investing is, at its heart, of battle of greed versus fear. And as with any battle, you need to have a game plan before starting. Or at least an outline of a game plan. I can’t imagine Manchester City starting a football season without points and trophy targets in mind. Neither would any professional athlete start a new season without ranking or tournament targets.
How do you decide on the right benchmark? Investing is a personal experience, and so the right benchmark will differ from person to person. It is good to have this conversation with your financial advisor to establish your benchmark. Once that has been done, then you can start to look for investments that give you the best chance of reaching that benchmark. That is sensible investing.
To help you in that conversation, you could think about benchmarking in two ways. The most popular method is relative benchmarks. For example, if you are predominantly investing in equities, you might choose the S&P500 Index – a basket of America’s 500 largest publicly trades companies – as your benchmark. And hopefully your investing over time does better than this benchmark.
A second way to look at benchmarks is absolute returns. Here you are saying you prefer to try and achieve 7 percent p.a. returns, for example. This return is independent of what any equity or bond market might do. Statistically this is harder to achieve than a relative benchmark but it doesn’t mean it is not important for many investors.
Many of us rarely follow this methodical approach. We are drawn to investments that offer get-rich-quick potential, or just the “FOMO” pressure to buy the latest hot investment. But this approach rarely works over time. Invest your time to decide the right benchmark and then work with your advisors to discover the investments that can deliver the benchmark returns with the highest degree of probability.
Ok enough on benchmarking. Let’s talk briefly about recent economic and financial trends in the world.
The successful vaccine rollout in the US and UK is creating optimism that these economies, among others, will re-open with a bang this summer. The US economy certainly looks like it will record strong GDP growth and consumption in the second half of 2021.
The flip side of this strong growth (that’s why economics is also known as the dismal science because there is always a but) is inflation. Too much money chasing too few goods. And inflation is new to many of us who have not lived through the 1970s or Argentina and Zimbabwe more recently. It can be a real downer if inflation picks up for financial markets.
If you are feeling particularly pessimistic about inflation, then gold is a good bet. Although I personally don’t see the need to be that worried about inflation. I suspect the increase in pricing we are seeing is transitory and that prices will start to calm down by the end of this year. That is certainly what the US Federal Reserve is hoping to see which would avoid the need to raise rates aggressively and spoil the party. The US bond market, also a good proxy for inflation fears, is also suggesting price pressures will abate after the summer.
So what do we do? Within the context of your benchmark, I believe it makes sense to have exposure to some investments like technology and consumer discretionary stocks that will benefit from strong growth, as well as commodity (energy and copper companies come to my mind) and industrial companies that will benefit from increased inflation in the economy.
Let the good times roll on.