The Advisor Insights question and answers can be found on Investopedia here.

Question Headline:

What does it mean when people say they “beat the market”? How do they know they have done so?

Answer:

When someone says they “beat the market” it generally means they have received greater returns than some benchmark. This phrase can be misleading because people use different indexes to compare their returns with.

Often times investors compare their returns to the Dow Jones Industrial Average, or the S&P 500. Neither of these are great representations of the entire market. The Dow Jones is one of the oldest indexes, which is one of the primary reasons people like using it. However, it is only comprised of 30 of the largest US companies, which doesn’t give someone an accurate “big picture” of the market.

The S&P 500, takes into account 500 of the largest US companies. This makes it a pretty good representation of US markets, and is what I typically cite when referring to US stock performance.  Depending on how it is calculated the US only comprises ~40-55% of the world market capitalization, so it doesn’t really make much sense referring to an index of only US stocks as “the market.”

I recommend that investors always be invested globally. Holding a combination of US and international stocks is one of the best forms of diversification and it should be taking an advantage of.

Indices like the MSCI World Index or the MSCI All Country World Index which take into account US and international stocks are a better representation of “the market” and are better benchmarks for investors. I personal use the Vanguard Total World Stock ETF (VT) as my investing benchmark. It covers approximately 98% of the world’s investable market capitalization with about 50% in US stocks, 40% in international developed stocks, and 10% in international emerging-market stocks.

It is also important to take into consideration what your portfolio looks like when comparing it to the market or a benchmark. If you only own small U.S. companies, it would not make sense to compare it to the Dow being 30 of the largest US companies. This phrase can mean a variety of things, so the next time you hear someone use it, it’s probably best to ask them to clarify their statement.

 

– Wyatt Swartz

– Contributions by Caitlin Lammers

– 7/3/2017