Choosing a Benchmark
A return means nothing on its own. What it is compared against determines whether it was good, and the comparison is frequently chosen to flatter.
MadStockAlerts Research · Updated August 29, 2026
What to take away
- A benchmark must be investable, and knowable in advance.
- It should match the portfolio's actual exposures, not its aspirations.
- Comparing a mixed portfolio against an equity index is a category error.
- Index returns are usually quoted before costs that any real holder pays.
- The most honest benchmark is the alternative that was actually available.
MAD Academy Training Video · 0:46
The Yardstick Decides the Verdict
Beating a benchmark means nothing unless the benchmark represents what you could have held instead.
This lesson is part of a Stock Alerts + Tools plan.
What makes a benchmark valid
- Investable: something that could actually have been held instead.
- Specified in advance: chosen before the period, not selected afterwards.
- Matched in exposure: the same asset classes, in roughly the same proportions.
- Measurable: with a published return that anyone can verify.
- Unambiguous: constituents and weights that are defined rather than described.
The second is the one most often violated, and rarely deliberately. Looking at several possible comparisons and reporting the one that shows the best relative result is a selection made after the fact, and it produces a number that describes the selection.
The common mismatches
| Portfolio | Frequently compared to | Why that is wrong |
|---|---|---|
| 60/40 equities and bonds | An equity index | It carries far less equity risk and will lag in a rally by construction |
| Small-cap holdings | A large-cap index | Different risk, different cycle, different constituents |
| An international allocation | A domestic index | Currency and geography make them different exposures |
| A concentrated set of positions | A broad index | Comparable in return and not in risk |
| A cash-heavy portfolio | An equity index | Comparing an asset held for stability against one held for growth |
Each mismatch produces the same kind of error: a comparison that flatters in one environment and condemns in the other, without either result saying anything about the decisions made.
The costs that are missing
An index is a calculation rather than a portfolio. Its published return generally assumes no transaction costs, no fees, no taxes and immediate reinvestment of dividends at the closing price.
- A fund tracking the index pays an expense ratio, which is deducted from the return.
- It pays transaction costs to track changes in the constituents.
- A taxable holder pays tax on distributions along the way.
- The total-return version and the price-return version differ by the dividends, and both are published.
The last item matters when comparing. A portfolio's return including dividends compared against a price-only index return is a comparison that flatters by the dividend yield, and the two versions of most indices are both freely available.
The most honest comparison
Beyond any index, one comparison is more informative than the rest: what would have happened by doing the simplest available thing. For a portfolio of individual securities, that is the corresponding index fund, held throughout, with no decisions.
That comparison is uncomfortable by design, which is what makes it useful. It measures whether the effort produced anything, against the option that required none.
It also has to be measured over a period long enough to mean anything. A year says almost nothing; several years including at least one substantial decline says considerably more, for the same reasons of sample size that apply everywhere else in this library.
Benchmarking a mixed portfolio
A portfolio holding several asset classes needs a benchmark that holds the same classes in the same proportions. Constructing one is arithmetic rather than judgement.
- 1Take the target allocationThe intended weights, not the current drifted ones.
- 2Pick an index for each classBroad, investable and matched in exposure.
- 3Weight the index returns by the targetsThe weighted sum is the blended benchmark return.
- 4Rebalance the blend on the same scheduleSo that the benchmark and the portfolio drift the same way between rebalances.
The fourth step is the one usually omitted, and omitting it makes the comparison unfair in whichever direction the market moved. A benchmark rebalanced monthly against a portfolio rebalanced annually is measuring the rebalancing frequency as much as anything else.