In its 63-year history, the S&P 500 Index has become the center of the investment universe. In many cases, investors would be wise to resist its gravitational pull. The index has become the default mechanism for gauging market performance. Its ubiquity has also caused many investors and investment professionals to mistakenly apply the index as a mental benchmark for relative performance, even though the strategy it is compared with may invest in entirely different markets or securities.
While comparing performance to the S&P 500 is easy, we have four reasons why investors should avoid such faulty comparisons.
- 1. Think globally, compare locally
- Even though the largest companies have a global footprint, U.S.-based companies are still tied closest to the domestic economy, and international companies are tied closest to the economies of their respective host countries or regions.
- 2. Currency differences count a lot
- Currency fluctuations can also have a big impact on the performance of different indices. This has been particularly true in past years, as the Federal Reserve was gradually raising interest rates.
- 3. Investment styles go in and out of favor, causing varied index performance
- Another factor making it dangerous to compare the wrong index is the varied performance of different investment styles.
- 4. Using the wrong benchmark undermines the basic tenets of modern portfolio theory
- Above all, a fixation on the S&P 500 subconsciously chips away at the foundation of modern portfolio theory.
Read more in our latest article, Mind the Benchmark: The Pitfalls of Defaulting to S&P 500 Comparisons >