Benchmarking Your Portfolio: Lessons from Wine Tasting & Financial Markets

Benchmarking Your Portfolio: Lessons from Wine Tasting & Financial Markets

February 26, 2024

Originally published in The Bulletin on February 26, 2024

If you’ve ever been wine tasting your host undoubtedly has poured a glass from a certain vintage and said, “This was a good year.” Maybe there were some challenges with the weather along the way, but the conditions improved at the right time and in the end the fruit turned out great. Similarly, the resilience displayed by financial markets in 2023 mirrors this narrative. Despite facing geopolitical conflict, a banking crisis, elevated inflation, and higher interest rates, the MSCI All Country World Index of global stocks saw a notable increase of 22.8-percent while the Bloomberg Barclays U.S. Aggregate Bond Index recorded a positive 5.5-percent gain.

While these returns were favorable, it’s not uncommon to hear investors lamenting the fact that their own returns failed to match those of the market. This is a common experience and there can be many reasons for its cause. Usually what we find when meeting with prospective clients is that their underperformance stems from a combination of factors by their investment managers: picking the wrong stocks, making incorrect tactical moves, trying to time the market, charging high fees, or a combination of all of these. If this scenario sounds familiar to you, you are not alone. In an ongoing study published by Dimensional Fund Advisors, close to 80% of investment managers fail to enhance client portfolios consistently. Those that may outperform in one time period tend not to repeat over the next.

To accurately assess investment performance, it’s imperative for investors to benchmark their returns against the broader financial markets. However, determining the appropriate benchmark can be challenging. For instance, evaluating the performance of a globally diversified portfolio with a balanced allocation between stocks and bonds requires careful consideration. Many investors often rely on widely available benchmarks, such as the S&P 500, commonly quoted in newspapers and financial media, as a point of comparison for their portfolio performance. However, this approach may not provide an accurate reflection, given that the S&P 500 comprises only the largest 500 stocks in the US market and lacks exposure to bonds. A blended return using both the S&P 500 and a bond index offers a slight improvement, yet it still fails to fully capture the portfolio’s diverse composition, which encompasses large, medium, and small company stocks, as well as international equities and bonds. Consequently, performance comparisons against a single index may misrepresent the overall performance of a diversified portfolio, which could outpace or lag behind the S&P 500 depending on the performance of different market segments.

Returning to our original wine analogy, comparing investment portfolios to wine varietals highlights the importance of selecting benchmarks that truly reflect their distinct compositions. Just as contrasting a Cabernet Sauvignon from Walla Walla with a Sauvignon Blanc from New Zealand illuminates significant disparities despite their shared classification as wines, the careful selection of benchmarks is crucial for precise performance assessment in investments.