Benchmarking
1. Benchmarking
Monitoring prices and returns allows you to assess the past performance of your investment on a stand-alone basis. It is now time to compare the performance with "a point of reference".2. What is a "benchmark"?
This point of reference, called a "benchmark" in finance, can be the performance of another stock or a financial index capturing the performance of the stock market as a whole. Actually, it can be any other asset whose nature or expectations in terms of return and risk is similar to your investment. Of course, you can compare the performance of a stock with the interests earned for the cash on a bank account, but this is not benchmarking. A benchmark is essential as it tells you if you made a good investment or not.3. Benchmark for stock ABC
Since the stock ABC is a traded share of a US company, it is reasonable to benchmark its performance with the performance of the US stock market. This can be achieved with a US market index, which can be computed as the average performance of major companies traded in the US stock market. Hence, benchmarking with the US market index tells us how ABC compares with US stocks on average.4. Benchmarking with cumulative wealth
Once the benchmark is defined, you can compare the final wealth of both investments should you have invested the same amount of money to the benchmark in the past.5. Benchmarking with cumulative wealth
For simplicity, it is common to set the initial amount to $100.6. Benchmarking with cumulative wealth
You then compute the evolution of this amount for the stock ABC and the benchmark over the past period using their respective monthly returns. You can then compare their evolution7. Benchmarking with cumulative wealth
and the final wealth.8. Cumulative wealth with Google Sheets
Comparing the cumulative wealth of two investments with spreadsheets is simple. Start by setting the amount corresponding to the first period equal to $100.9. Cumulative wealth with Google Sheets
Next, compound the initial amount using the first periodic return. For the ABC stock, you can achieve this by multiplying the initial $100 by one added to the monthly return of January 2013.10. Cumulative wealth with Google Sheets
Finally, use the "autofill" feature to complete the table.11. Cumulative wealth with Google Sheets
To have a clearer overview of these values, you can display them using a line chart. You can modify the axes of the chart for a better display.12. It's time to practice!
In the upcoming exercises, you will compare the performance of the stock ABC with a US stock market index. Time to practice!Create Your Free Account
or
By continuing, you accept our Terms of Use, our Privacy Policy and that your data is stored in the USA.