Benchmarking Asset Allocation Investment Performance Using Indices

Kent E. Irwin is the President and Co-Founder of eFinplan, LLC, the first online comprehensive financial planning software for consumers. He is also a Chartered Financial Consultant (ChFC), a Chartered Advisor in Philanthropy (CAP) and a Chartered Life Underwriter (CLU).

My article entitled The Asset Allocation Style of Investing, highlighted this method of investing made popular from the study by Garry P. Brinson, Brian D. Singer, and Gilbert L. Beebower that found that over 91% of long-term portfolio performance is derived from the decisions made regarding asset allocation, and not market timing or security selection.

In that article I compared 5 fictitious model portfolios to help demonstrate different risk levels: very conservative ‘Volvo portfolio’, conservative ‘Lexus portfolio’, moderate ‘Acura portfolio’, aggressive ‘BMW portfolio’, and lastly the very aggressive ‘Porsche’ model portfolios – each investing in a different mixture of cash, bonds and stock, as well as different allocations of large, mid and small cap stock and foreign stocks.

The chart below provides historical rates of return for each asset allocation model from the article, based upon the respective indices. Investors should take into consideration expenses and timing and have a healthy historical perspective.

The Expense Factor

The table below compares the GROSS rates of return that you would have earned in any of these portfolios if you invested in index funds that held investments identical to the index. Gross rates of return are before any expenses, such as:
* Mutual fund management fees and expenses
* Taxes
* Commissions
* Transaction costs
* Financial planner’s management fee


In order to have earned these rates of return, you would have had to invest at the same precise time of the time period represented. Fluctuations in the market can make a drastic difference in your actual rate of return, so if you invested a lump sum of money on a day that the market was down or up, or you invested each month (perhaps using dollar-cost-averaging), you may and will experience quite a bit different results than illustrated here.

Historical Perspective of Indexing

Index fund investing (passive) has been popular because people hear in the media frequently that a majority of actively managed mutual funds do not consistently beat their respective index.

Actively managed mutual funds usually have higher expenses, thus making it more challenging for them to out perform their passive brethren. However, investors may want to consider looking for mutual funds that beat the indexes (net of expenses), they might even find some that have a lower risk (volatility) than their index.

The preference to invest in index funds is a fairly recent phenomenon. Now you can even invest in ETFs or exchange traded funds, a hybrid of index investing that has emerged in the last several years. The charts below illustrate returns all the way back to 30 years, however index funds and ETF’s didn’t exist for each of the indexes used to make these calculations back that far.

Past Performance an Indication of Future Performance?

Anyone who as ever glanced at any financial product advertising or literature will see “Past results are not an indication of future performance” pasted all over the place. This sentence is required by the security industry’s regulating authorities and it is very true. However in order to make intelligent decisions, historical information is very useful for comparison purposes, in addition to a lot of other financial information including your own personal financial plan.

The Indexes

The indexes used to compile the historical rates of return are below. Keep in mind there are dozens of different indices. These ones many feel most closely represent the benchmark for each category. There is some differing of opinion in the investment community as to the best indices that should be used for benchmarking.
* Cash – Money Market (3-month CD
* Intermediate Long Bond – Lehman Bros Aggregate Bond
* Large Cap Value — S&P 500
* Mid Cap — Russell Mid-Cap Index
* Small Cap – Russell 2000
* International Equity – MSCI EAFE Equity Index.

Historical Rate of Return

Portfolio Model

Model Type
Very Conservative
Very Aggressive

1 year

3 year

5 year

10 year

20 year

30 year

If you do your own investing – active or passive or hire someone to invest for you, it is prudent to make sure that you are doing as good as the benchmark. The benchmark is a minimum expectation of rate-of-return that you should be achieving. It is a way to hold yourself or your investment advisor accountable. It is important that you know why your investments are either not doing as well or much better than the benchmark. Either could be cause of concern: it could be merely a timing issue or it could be because your advisor made a mistake or is not doing their job. It is important that you are in the know and asking the right questions, and getting the right answers.

Asset allocation investors do not just invest in funds similar to the S&P 500 or the DOW (the most common benchmarks), therefore they should compare their results to aggregated benchmarks that include indices that closely match their allocations.

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  1. Kent Irwin

    These returns are through 12/31/07. The 5-year returns are very attractive, covering in part the most recent bull market. The 10-year returns don’t look as attractive given that they include a couple of bear markets.

  2. Rick Francis

    A comment on the timing- Since I can’t start investing back in time I would much rather see results that are averages over several starting points rather than the results from a single starting point.

    Averaging the results over sever starting points should give a much more reliable mean. Additionally, you could also show standard deviations to give an idea of how volatile the results are too!

  3. Chris

    Thank you, thank you, thank you. I am so tired of investment articles online (including a recent guest column on this very site) offhandedly stating “Assuming an 11% return…”. This GROSS EARNINGS chart shows just how ridiculous a claim that is for the average investor. Thank you for a dose of realism.

  4. Roman

    Picking the right investment is much like picking a car its what you want at the time. If you want something for a short term then you get one things but for the long is another. Same goes for the risk, not everyone’s risk to reward is the same. This is a great article though.

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