Benchmarking Mutual Funds: Are You Missing the Mark?

Curt Pouyer |

As the stock market volatility continues, investors are reawakening to the performance benchmarks of their mutual funds to see if their fund choices are drawing every ounce of gains that have been produced over the last couple of years. As investors pour more of their assets back into stock funds, they are, once again, feverishly comparing their funds’ performance against the indices (Dow Jones, S&P500, Nasdaq) as a gauge of the quality of advice they are receiving.

Benchmarking has become a standard practice for investors especially with the proliferation of mutual funds on the market all vying for attention. TV ads and investment newsletters blast benchmark results on a daily basis, creating a herd mindset that they must be important. Also, as the number of indices has grown over the years, investors have more ways to compare their funds; but, can this method of evaluation provide investors with the kind of information that can properly guide their investment choices over the long term?

Why MF Benchmarking May Not Work

As many studies indicate, mutual fund managers who turn over their funds frequently (buy and sell the positions that make up the fund) rarely achieve returns that beat the market. It is also common knowledge that the vast majority of fund managers fail to consistently beat their own benchmarks. And, to the herd of MF investors, very few funds that do track or beat the benchmarks in a given year go on to repeat that performance consistently in subsequent years. CNBC reported three stats on March 16, 2022. 1) At year end 2021 79% of active fund managers underperformed their benchmarks.  2) Over the last 10 years, 86% of active fund managers have underperformed.  3) 70% of mutual funds go out of business due to performance.  The reasons for this is not that fund managers are not capable but more so because of fees, over confidence, market timing and competition.

While benchmarking mutual funds is a valid way of evaluating funds, investors may be missing the mark if they rely too heavily on them for making their investment decisions. By focusing on fund performance as compared to the market, investors may become overly sensitive to the market risk they are assuming and make abrupt decisions in an effort to mitigate the risk or chase surging mutual funds. There is a better way!

What’s the Real Target?

If your mind is set that mutual fund investments is right for you, than investors fund performance should be benchmarked using their own financial objectives. With this mind set investors wouldn’t be inextricably bound to the relative performance of the markets. Rather, by using a more absolute measure - your own financial objectives - decisions can become clearer and more forthright.

For instance, if, through your planning, you have determined that, in order to reach your retirement objective, your funds need to grow at a rate of 6% per year, how much does it matter what one mutual fund is doing versus another or versus an index, so long as your overall portfolio is achieving a 6% return. Trying to benchmark your mutual funds against irrelevant indices is a distraction at best, but it is more like taking your eye off the ball.

What’s the Alternative?

There is absolutely nothing wrong with trying to manage your mutual fund portfolio in an effort to earn the best possible returns, but if your sole objective is to outperform the market each year you may find more frustration than success. Very few people have ever become wealthy investing in mutual funds; however, millions have used them to help them achieve their financial goals.

You’ve done the planning. You’ve defined your objectives. You know where it is you want to go, and the stock market is simply one vehicle to help you get there. By taking a long term approach and selecting individual stocks with strong fundamentals, respectful market tenure, and being well diversified across different industries will create a well balanced, risk adjusted portfolio.  Essentially what you are doing is building your own personal mutual fund without all the expenses and uncertainties. This strategy will help you achieve your goals with less risk and more return. 

If this strategy intimidates you, there is nothing wrong with the mutual fund passive approach but your expectations should not be set too high.  There are too many fingers in the mutual fund pie which in turn hinders an investors returns.  If you are intimidated but like the idea, find an investment advisor that you can relate to.  

In conclusion, it is important to have a relative benchmark to your investments, but when it comes to benchmarks or expectations, the  only benchmark that really matters is whether you are on track to meeting your own objectives.