You will be able to choose a fair benchmark for a portfolio and explain why a mismatched one misleads.
At a family dinner Marcus's brother-in-law mentions that his portfolio returned 4% last year, which he says beat the market. When Marcus asks which market, the answer is an SGD bond index, and the portfolio is mostly bank shares. So the comparison was between a bank-heavy account and a bond index in a year when the bond index happened to do worse, and it says nothing about how well he chose.
A return on its own tells you little. It becomes information when you set it beside the return you could have had by doing something simple instead. That simple alternative is your benchmark, and choosing it badly is the easiest way to fool yourself.
A fair benchmark passes three tests.
It is investable. You could have bought it, through an index fund or ETF, at a cost close to what the index shows. If nobody could have held it, it's a wish list rather than something you passed up.
It is specified in advance. You choose it before the period starts and keep it. Choosing a benchmark after you know the results means picking the one you beat, and fund managers who change benchmarks after a bad stretch are doing exactly that.
It holds roughly the same kind of risk as your portfolio. If you hold 80% shares, the benchmark should hold about 80% shares. If your shares are spread around the world, so is the benchmark's equity part.
The brother-in-law's mistake runs both ways. Set a share-heavy account against a bond index and you'll look brilliant in most good years, because shares tend to return more than bonds over time in exchange for deeper falls, and you'll look terrible in a crash. Neither verdict says anything about your choices. The gap is mostly the equity premium, which module 2 covers in lesson 2.7, Risk premia: what you are paid to hold equity, term, credit and illiquidity.
The reverse mistake is common among cautious investors. Someone with half their money in T-bills compares themselves with a world equity index, trails it in every rising year and concludes they're bad at investing, when all they did was choose lower risk. Their benchmark should carry the same T-bill share.
Singapore investors run into a third version: comparing a global portfolio with the STI because it's the index on the local news. The STI is concentrated in a few sectors, with banks carrying a large weight, so it behaves differently from a world index. Unless your portfolio looks like the STI, it isn't your yardstick.
Most portfolios hold more than one kind of asset, so the benchmark should too. A blended benchmark combines two or more indexes in fixed weights that match your target allocation.
Marcus's written allocation, from the course Build and run an ETF portfolio, is 80% shares and 20% bonds and cash, with a small tilt to Singapore. So his blended benchmark is 70% a world equity index, 10% the STI and 20% an index of Singapore government bonds. In a made-up year where the world index returns 12% in SGD, the STI 6% and the bond index 2%, the blend returns 0.7 times 12, plus 0.1 times 6, plus 0.2 times 2: 9.4%. If Marcus's own time-weighted return that year was 7.8%, he trailed his benchmark by 1.6 points, and that comparison is fair.
Two details keep the blend honest. Rebalance it on a fixed schedule, such as yearly, in your spreadsheet, so its weights don't drift with the markets. And keep the weights equal to your target allocation, not to whatever you happen to hold today. If your stock picks have pushed you to 90% shares, the benchmark staying at 80% is what shows you that extra risk was taken.
The benchmark has to be measured under the same convention as your own figures, or the comparison is broken before you start. That means total return, with dividends reinvested, using a net version where one exists, as lesson 1.2 explained. It means SGD, restated from US dollars where needed with your chosen rate source, as lesson 1.3 set out, over exactly the same dates as your own figures.
Index data is usually published by the index provider, and an ETF tracking the index is a practical stand-in when the index itself is hard to get. Using an ETF's total return in place of the index has an advantage: it already includes the fund's costs, so it's closer to what you could actually have earned. Lesson 3.2 of Build and run an ETF portfolio, Tracking difference is what you actually lost to the index, explains the gap between the two.
Write the benchmark down once with three things for each part: the index, its weight and where its data comes from. Then don't touch it unless your target allocation changes, and if it does, note the date. That written line is what the returns tab in lesson 1.8 will measure you against.
Write down the blended benchmark for your current portfolio, with each index, its weight and where you will get its data.
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