To know if your portfolio is beating the market, you must compare your total returns against a relevant benchmark index, such as the S&P 500, over the same time period. Simply looking at account growth is not enough; you need to account for deposits, withdrawals, and risk-adjusted returns.
Choose the Right Benchmark
Comparing a tech-heavy portfolio to a global bond index makes little sense. Select a benchmark that aligns with your asset allocation. For a standard U.S. stock portfolio, the S&P 500 or Total Stock Market Index is the standard yardstick.
Calculate Time-Weighted vs. Money-Weighted Return
- Money-Weighted Return (IRR): Measures your personal dollar growth, heavily influenced by the timing of your deposits and withdrawals.
- Time-Weighted Return (TWR): Measures the pure performance of your investments by removing the impact of cash flows. TWR is the best metric to see if your stock-picking or fund selection outperformed the benchmark.
Account for Risk
Beating the market by taking twice the risk is often a losing long-term strategy. Review metrics like the Sharpe ratio to determine if your excess returns compensated you adequately for the volatility you assumed.
Automate Your Tracking
Manually calculating returns and adjusting for cash flows can be complex. Platforms like Samet allow investors to track their portfolio performance and compare it against major market benchmarks seamlessly without manual spreadsheets.
FAQ
What is the best benchmark for a diversified portfolio?
A blend of indexes, such as the S&P 500 for equities and the Bloomberg Aggregate Bond Index for fixed income, is usually the best benchmark for a diversified, multi-asset portfolio.
Why use Time-Weighted Return (TWR) instead of overall profit?
TWR eliminates the distortion caused by adding or withdrawing money, showing the true performance skill of your investment choices compared to the broader market.
Should I include dividends when calculating performance?
Yes. Total return calculations must include both capital appreciation and reinvested dividends to provide an accurate comparison against total return indexes like the S&P 500 TR.