Index Investing & Benchmarks

The S&P 500^® Index and the Dow Jones Industrial Average^® are familiar indices that appear daily in the media so they're often what investors turn to first in tracking financial markets and trying to understand their portfolio's performance. But are those the right "benchmarks" for your portfolio?

What is an index?

An index is a collection of securities, typically in one asset class, that are used to track movement in the market for that particular segment. For example, both the S&P 500 and the Dow Jones Industrial Average measure the U.S. large cap stock market segment or asset class. The S&P 500 consists of approximately 500 large U.S. companies, while the Dow is a narrower index that consists of just 30 large companies. Each index measures only a portion of the U.S. large cap asset class, with the index constituents selected in each case by a committee.

Benchmarking and asset classes

If you're a self-directed investor whose portfolio consists of a handful of well-known stocks that you've selected, measuring your portfolio's performance against a benchmark such as the S&P 500 could be relevant. That performance comparison could give an indication of how successful you've been in picking stocks vs. taking a passive index approach by investing in an S&P 500 fund. But what if your portfolio consists of multiple asset classes beyond just U.S. large cap stocks, such as U.S. small cap stocks, international stocks, bonds and other asset classes?

Measuring the performance of multi-asset portfolios

Diversified portfolios such as Schwab Intelligent Portfolios^® should not be measured against a single index because the portfolios include asset classes beyond just U.S. large cap stocks. Each asset class in a multi-asset portfolio may have a different appropriate index or indices to compare against.

For example, the index for U.S. small cap stocks is typically the Russell 2000^® Index or the S&P 600^® Index. For international developed market large cap stocks, the index is typically the MSCI EAFE Index or the FTSE Developed ex U.S. Index. For investment-grade corporate bonds, the Bloomberg U.S. Corporate Bond Index is often used. Bond indices typically have sub-indices for various maturity ranges as well, such as the Bloomberg U.S. 5-10 Year Corporate Index, which focuses on intermediate-term investment-grade corporate bonds with maturities between 5-10 years.

There are a variety of index providers including S&P, Dow Jones, MSCI, FTSE-Russell, Bloomberg and others. Major index providers typically have full suites of indices covering various geographies and asset classes, so there are often multiple indices with different index construction methodologies that measure the same asset class. What's most important is that you use an index that tracks the right asset class.

Figure 1: A few common indices for various asset classes

Source: Charles Schwab Investment Advisory, Inc., as of December 2022

Compare each ETF in your portfolio with its underlying index

Schwab Intelligent Portfolios uses exchange-traded funds (ETFs) as the individual asset class building blocks to construct your portfolio. Each ETF is designed to track an underlying index designated by the fund provider. The measure of success, or benchmark, for an index investment such as an ETF is not whether it's doing well or poorly at any given time, which will fluctuate with the market environment, but whether the ETF is closely tracking its underlying index.

An ETF that doesn't track its index closely would not be fulfilling its objective because it wouldn't be accurately representing the asset class. However, an ETF in each asset class would be performing as expected in both up and down periods if it accurately tracks its underlying index. The constant movement up and down the performance rankings for different asset classes is why it's so important to invest in a diversified portfolio that includes multiple asset classes.

Keep in mind that small differences in performance between an ETF and its underlying index are to be expected because an ETF has an expense ratio that the fund provider charges for managing the fund while index performance does not include any expenses because indices are unmanaged and cannot be invested in directly. In an endeavor to keep costs low for clients, Schwab Intelligent Portfolios focuses on selecting ETFs with among the lowest expense ratios that also meet our other selection criteria.

For example, the Schwab U.S. Large-Cap ETF (SCHX) included in Schwab Intelligent Portfolios has an annual expense ratio of just 0.03% and is designed to track the Dow Jones U.S. Large-Cap Total Stock Market Index. As discussed above, this index measures the U.S. large cap stock market segment. You can see below that the ETF (light blue) tracks its underlying index (dark blue) very closely over the 1-,  5- and 10-year periods shown.

While the ETF's underlying index is different from the potentially more familiar large cap stock index, the S&P 500 Index, you can see that the ETF tracks relatively closely to that index as well, particularly over longer periods. The reason for potential performance differences between the two indices in shorter periods is that the Dow Jones U.S. Large-Cap Total Stock Market Index includes approximately 750 large U.S. stocks, so it has broader coverage of the U.S. large cap stock market segment than the S&P 500.

Figure 2: ETFs are index investments designed to closely track their underlying benchmark

Source: Charles Schwab Investment Advisory, Inc., using data from Morningstar Direct, as of 12/31/2022

Consider the risk profile of your portfolio allocation

Another reason it doesn't make sense to measure your diversified portfolio's performance against a single index is that Schwab Intelligent Portfolios includes different allocations across stocks, bonds, commodities and cash. The combination of asset classes in your portfolio determines its expected returns and volatilities, or risk profile, across the spectrum from Conservative to Aggressive Growth. Investing in a diversified portfolio is designed to help moderate portfolio volatility over time compared with a highly volatile all-stock index. 

• A Conservative portfolio that emphasizes bonds would not be expected to keep up with an all-stock index such as the S&P 500 when stocks are rallying but would also not be expected to decline as much as the index when stocks are tumbling. 
• Likewise, a Moderate portfolio with a more balanced mix of stocks and bonds would also not be expected to keep up with an all-stock index when stocks are rising or decline as much as the index when stocks are falling.  
• Even an Aggressive Growth portfolio would not be expected to track the S&P 500 because it includes other asset classes, such as U.S. small cap stocks and international stocks. At any time, an Aggressive Growth portfolio might be performing better or worse than an all-stock index based on how those other asset classes are performing. 

The indices most relevant for your portfolio depend on which asset classes it holds and where it is positioned along the risk spectrum.  You can customize your dashboard's performance tab by selecting up to five different indices, which can help you understand which asset classes are doing best or worst over the period you're examining. The indices performing best and worst will change over time depending upon the market environment, but over the long term, your diversified portfolio would be expected to track somewhere between them. Keep in mind that your portfolio is broadly diversified across up to 15 asset classes, so it would not be expected to track any of these single indices directly.  

Figure 3: Risk profiles and their relevant asset classes and indices for Schwab Intelligent Portfolios

Source: Charles Schwab Investment Advisory, Inc., as of 12/31/2022

Progress toward your goals is the most relevant measure

The best way to assess your portfolio's performance can be confusing when the markets are moving up and down. While the S&P 500 and Dow are often looked to for a general understanding of market behavior, they're typically not relevant benchmarks for your overall diversified portfolio. Take a few minutes to understand the individual investments in your portfolio and the appropriate benchmarks for each asset class.

Most importantly, how you're tracking toward your goal is the most relevant measure of success. Simply aiming for the highest returns is often counterproductive because it  frequently leads investors to take far more risk than they need to in order to have a high probability of achieving their goals. And when markets turn rocky, the turbulence can sometimes lead to poor decision-making that throws investors off track from their financial plan. The goal tab of your Schwab Intelligent Portfolios dashboard allows you to set up your goal and monitor your progress toward it after you've logged in and selected your account. For Schwab Intelligent Portfolios Premium clients, log in and visit your overview page to view your probability of success.

David Koenig CFA^®, FRM^®, is Vice President and Chief Investment Strategist for Schwab Intelligent Portfolios

Investing in a portfolio with the right mix of both risk and return based on your goal and risk profile is key to long-term investment success. Our team of investing experts designed Schwab Intelligent Portfolios to do this for you automatically.