Benchmark—A Road Map and Measuring Stick

What exactly is a benchmark? A benchmark is your portfolio road map, but it’s also a measuring stick for telling you what’s reasonable to expect and how good a job you’re doing getting there.

But more simply, a benchmark is any well-constructed index. By “well constructed,” I mean market capitalization-weighted (like the S&P 500 index or the MSCI World or ACWI indexes) and not price weighted (like the Dow).

The Dow is a popular but near-useless stock index that survives mostly out of tradition. I’ve written extensively on why you should ignore the Dow in my other books, and if you care to read more, I direct you to The Only Three Questions That Still Count or Appendix A (which reprints the pertinent chapter from my 2010 book, Debunkery). But briefly, the price-weighted construction means a stock with a higher price per share has more influence on index performance than a stock with a lower price per share—even if the lower-price-per-share stock is from a firm that’s vastly larger in size (i.e., market capitalization). And year to year, index performance can get heavily skewed—even be arbitrary—based on which stocks split versus which don’t and/or whether high- or low-priced stocks do better. Priced-weighted indexes don’t reflect economic reality. And you want a benchmark that reflects reality.

Instead, use a market cap-weighted index—there are plenty. (Most major indexes now are market cap weighted. The industry has largely moved away from ...

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