The question
A fund says it returned 8% a year. Is that good? Compared with what?
The idea
- A return means little alone. You judge it against a benchmark: the yardstick a fund is measured against, ideally a simple, low-cost alternative holding the same kind of things. The right benchmark answers one question: did this fund do better or worse than the plain version of itself?
- Two cases:An index is a list of holdings picked by fixed rules, such as the S&P 500. An index fund holds everything on its index, at the index's weights, so its benchmark is that index.For a fund that mixes things, the benchmark is a matching mix.
- Measure a stock and bond fund against stocks alone, and you are judging a swimmer by a runner's time.
Worked example
AOR is an ETF from iShares that keeps about 60% in stocks and 40% in bonds. Reading through to everything it holds, ETFIQ finds 61.1% in stocks.
Follow $10,000 from Oct 31, 2016 to Oct 30, 2026 against two yardsticks. (As in lesson 1, the benchmark years before October 2026 are hypothetical.)
| 10-year total return | $10,000 became | A year | |
|---|---|---|---|
| AOR | +118.10% | $21,810 | +8.11% |
| Yardstick A: ETFIQ Global Stocks (100% stocks) | +220.75% | $32,075 | +12.36% |
| Yardstick B: ETFIQ Strategic 60 (60% stocks, 40% bonds) | +117.72% | $21,772 | +8.09% |
Against yardstick A: $32,075 − $21,810 = $10,265 behind. A year: 8.11 − 12.36 = 4.25 points behind. AOR looks like a poor fund.
Against yardstick B: $21,810 − $21,772 = $38 ahead. A year: 8.11 − 8.09 = 0.02 points ahead. AOR did what a plain 60/40 mix did.
Same fund, same ten years, opposite verdicts. Only yardstick B holds what AOR holds. The gap against A is not AOR's failure; it is the 40% in bonds that AOR is built to hold.
(A "point" is a percentage point: 8.11% minus 8.09% is 0.02 points.)
The common mistake
"Every fund should be compared with the S&P 500." Only a fund that holds large US companies should. A bond fund, a 60/40 fund or a gold fund has a different job, so the S&P 500 tells you about the market, not about the fund.
You will see broad indexes in official places too. US rules require a fund's yearly report to show a broad market index, and AOR's uses a world stock index, also shown on its ETFIQ fund page. That tells you how AOR did against the market. To judge AOR itself, use the matched 60/40 mix, as the ETF Models pages do.
A second trap is picking the yardstick after seeing the results. Choose it from what the fund holds, before you look at returns.
Check your understanding
Pick an answer to see why. Two of three right passes the lesson.
1. What makes a benchmark the right one for a fund?Answer: B. It holds the same kind of things the fund holds. A benchmark is the plain version of the fund, so it must hold what the fund holds. Not C: the S&P 500 only fits funds of large US stocks.2. AOA holds about 80% stocks and 20% bonds. Over ten years it returned +164.06%. Which comparison tells you how AOA did?Answer: B. ETFIQ Strategic 80, +165.23%. Strategic 80 holds the same 80/20 mix, so the small gap (about 1.2 points over ten years) is AOA's own result. Not A: AOA would trail all stocks by design, because a fifth of it is in bonds.3. An index fund's benchmark is usually:Answer: A. The index it copies. An index fund aims to match its index, so its index is the fair yardstick. Not B: comparing with the top performer, picked after the fact, makes almost everything look bad.
Takeaways
- Never judge a return alone: ask "compared with what?"
- Pick the yardstick from what the fund holds, not from what did best.
- Before trusting any comparison, check that the benchmark named beside the number holds what the fund holds.