The Benchmark Myth

We’ve all heard it.  We’ve all read it.  Most managers fail to match, let alone beat, the market.   

Actually, it makes sense!  And, there are two reasons for this:


First, if you believe – probably rightly so – that institutional managers of giant pension plans, mutual funds, etc., actually comprise most of the trading volume, then you begin to realize the managers ARE the market.   So, half should be above and half below average.  Why aren’t they?   That brings us to the second reason:  Expenses.   You see, indexes don’t have expenses.  You can’t even buy an index.   You can purchase an index mutual fund or exchange-traded fund (ETF) that replicates an index, but not the index.  Managers, however, are judged on portfolio net-asset-value (NAV) – the value after expenses. 

Let’s use an example you experience every day:  Your house. 


Suppose you bought a house for $250,000 and it appreciated in value right along with the overall housing market growing at 5% per year for 13 years (remember those days? - We'll use a happy figure for this hypothetical scenario; no sense being depressing). 


Did you tie the market? 


Let's use some assumptions you would have to take into account to report YOUR performance: 

1.     Property taxes are and remain at 1% per year

2.     Insurance is only 0.5% of value each year

3.     Maintenance is less than 1% and rises at 3% per year

4.     Final selling costs are only 3%, which occur in the final year

5.     Moving costs, loan interest expenses, and cash flow loss is ignored (wouldn't that be nice in real life?).


   What does your performance look like?




Prop Txs

Ins. Exp.
































































































The market did 5% per year; but YOUR record was 4.6% per year.   So, your record looks like it’s only 0.4% below market, right?     But, that 0.4% represents an 8% underperformance (0.4 divided by 5).  In our example,  $22,421 behind the market.


Your house may have tied the market – but you, the 'manager',  didn’t.  


Now you know why my most managers don’t outperform the index.  Collectively, they ARE the index; but they have expenses, and the 'indexes' don't.



Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and in his 21st year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.  The Independent Financial Group does not sell financial products or securities and nothing contained herein is an offer or recommendation to purchase any security or the services of any person or organization.  Visit The IFG Blog.


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Comment   |  7 years, 7 months ago from Moorpark, CA