October baseball hasn’t been this good in 11 years. Okay, I’m a bit biased because that’s how long it’s been since the Philadelphia Phillies were in the playoffs. As a baseball fan, it could be worse. The Seattle Mariners have never even made it to the World Series in their 45 years of existence. The scarcity of success (unless you’re the Yankees) adds urgency to those years a team does makes the playoffs. A season-end collapse, or getting bumped in the first round is a deflating end to a long, 162-game season.

Watching the early games of this year’s championship run brought to mind the concept of benchmarking. Baseball teams love to commemorate their success – whether it be a division championship, league championship or the ultimate World Series championship. If you watch the games, broadcast cameras frequently pan across banners hanging from each ballpark that serve as reminders of achieving these benchmarks. Benchmarking baseball success is easy. All 30 major league teams are working towards the same goal of a World Series championship.

A number of common benchmarks are used in the financial industry as well. Turn on any news network and you will inevitably hear how much a certain benchmark index has risen or fallen that day. Three benchmarks are most commonly referred to, and it’s helpful to understand what they are actually measuring and how they are best used in tracking the market.

 

Three Strikes

Perhaps the most commonly used financial benchmark is the S&P 500 Index. From media mentions to inclusion in performance reports, the S&P 500 is widely considered a measure of overall stock market performance. As you might guess from its name, the index tracks the performance of 500 companies. It is a market capitalization-weighted index. The return each company contributes to the index is “weighted” by the total dollar value of its outstanding stock. Remarkably, while the S&P 500 is dominated by large companies, the top 1% of the companies it tracks (Apple, Microsoft, Amazon, Tesla and Alphabet) account for over 20% of the index’s performance.

A second benchmark frequently referenced is the Dow Jones Industrial Average (Dow). Unlike the S&P 500, the Dow is a price-weighted index. In its simplest form, a price-weighted index adds up all the stock prices in the index and then divides the sum by the total number of stocks to determine a performance value. The Dow is an older index than the S&P 500, but is significantly less diverse as it only tracks 30 companies.

The third benchmark that is widely used is the Nasdaq Composite. Similar to the S&P 500, the Nasdaq is a market capitalization-weighted index. Unlike the S&P 500, it measures the performance of broader collection of 3,700 companies. While broader, and inclusive of international companies, it is also a highly skewed index with over 50% of its composition being technology companies.

 

You’re Out

Both the S&P 500 and Dow Jones Industrial Average are maintained by a common entity: The S&P Dow Jones Indices. S&P stands for “Standard and Poor’s.” As benchmarks for specific investor goals, I would argue that all three widely used benchmarks are exactly that: both standard and poor. From a technical standpoint, it simply doesn’t make sense to benchmark the performance of a diversified portfolio – containing small, mid, large and international companies – against an index tracking the performance of only a part of a single market segment.

A much larger problem is the disconnect between an investor’s personal financial goals and the performance an industry benchmark’s is tracking. No investor retirement date, risk profile or retirement income need are exactly the same. Such disparate investor priorities call for equally disparate benchmarking.

 

MVP

This is where an individual financial plan is truly beneficial. By outlining a clear path to achieving an investor’s financial goals, the financial plan becomes a uniquely personalized benchmark. This is one reason Evenkiehl is a financial planning firm first. Without the financial plan, investment management lacks direction, and advisors do their clients a disservice by simply tossing arbitrary benchmarks into performance reports.

In reality, the S&P 500 performance doesn’t matter so much as long as the financial plan is on track for success. There is greater peace of mind for both advisors and clients to mutually acknowledge, “Yes, the S&P 500 has dropped this year, but the financial plan’s probability for success has not.”

Before the playoffs start, major league baseball teams trim their active rosters down to only 26 players. Essentially, they’re required to bench the players they decide are least likely to help them in their playoff run. Perhaps it’s time we bench the benchmarks least helpful in measuring the success of financial goals.

 

Jonathan is the founder of Evenkiehl, LLC, an independent, fee-only Registered Investment Advisor located in Lancaster, PA serving clients locally and across the US.