You make your financial advisor accountable for beating the stock market. You make the S&P 500 index fund your proxy for the performance of the stock market. Therefore, the S&P 500 is your investment performance Benchmark.
However, the S&P 500 may or may not be an unfair benchmark. What does fairness have to do with the performance of your assets? If you are going to hold your advisor accountable for outperforming a benchmark it should be a fair benchmark that reflects how your assets are actually invested.
For example, the S&P 500 is a large capitalization, cap-weighted index of 500 stocks. Large cap (shares outstanding x price) are large companies that dominate their industries. But, the Standard & Poors compounds the impact of size by making the index cap-weighted. That is, the companies with the largest capitalizations have a disproportionate impact on the performance of the index.
What does this have to do with you? This index is an excellent benchmark if 100% of your assets are invested in large capitalization stocks. You are comparing apples to apples. But, what if your assets are invested in small cap, mid-cap and large cap stocks? This benchmark is no longer applicable or fair.
You need a benchmark that uses several index funds that more closely mirror your actual investments. And, you may need foreign investments, REITs (Real Estate Investment Trusts), and various types of fixed income investments. In fact, you may need five to ten index funds that replicate the performance of your assets.
How about asset classes you don’t invest in? Index funds that represent the performance of these asset classes should be included in your benchmark. This is reasonable as long as your financial advisor has the latitude to invest in these asset classes, but chose not to. For example, you include the performance of REITs in your benchmark. Your advisor recommends a zero commitment to REITs. No REITs in your portfolio reflects the advice you received from your advisor. However, that does not mean you remove REITs from your investment performance benchmark. Your advisor is accountable for his zero recommendation for REITs.
You also have to take asset allocation into consideration when you make advisors accountable for beating your benchmarks. For example, a high-risk investor may have a 75% commitment to stocks and a low-risk investor may have a 25% commitment. You have to select the Benchmark that best reflects your tolerance for risk. Asset allocation will vary by investor.
It is up to your financial advisor to beat the investment performance of your benchmark using asset allocation and selection. If he is right, he should outperform your benchmark. If he is wrong, your benchmark will win the performance race. If he consistently under-performs, he should be replaced and that is one more reason why the process should be fair.