As we write this post, the NIFTY provided over 30% returns in the last three months. So, should your investments have done the same?
All of us have a different combination — we have investments in equity, fixed income, real estate, other businesses etc. While real estate prices are down in the last three months, fixed income was up thanks to government intervention. Each asset class needs a different comparison metric.
A comparison metric depends on the defined criteria. For instance, you could compare against:
Investors in the same location
Investors with careers in the same industry
Investors with the same income and expense
All investors in the same asset class
In general, a comparison metric should be representative of the collective performance of investors in the asset class. For instance, you could compare real estate returns against the returns made by all real estate investors in the same location.
With public equity, we compare against investors with the same basket of stocks.
Let’s start with the smallest basket — say one stock, TCS. The total return in TCS is the combined return of all investors in TCS. Now, let’s choose two stocks — TCS and Reliance. The combined return of all investors in TCS and Reliance is the return of each stock added in proportion to the weights of total investor money in each stock (market value). Now, we define another price where we combine individual stock prices in proportion to the total market value of these stocks — we call these indices. You can choose entire universe of large, mid and small-cap stocks and you would get the NIFTY 500index.
Returns from the index represent the combined returns of all investors across all stocks of the index.
So, if you want to compare against all investors across all types of stocks, you can choose the NIFTY 500 as your comparison metric.
Several of us choose only specific categories of stocks, based on size. For instance, at THRIVE, we stick to large and mid-cap allocations. So, one of our comparisons is against the NIFTY LargeMidcap 250 index (this combines all the large and midcap stocks). You can go further down and select defined baskets that make up different indices — NIFTY 50, Nifty Next 50, NIFTY Midcap 150.
Can you invest in an index? Yes, but only in public equity through index funds and index ETFs. They invest in a combination of companies in the same weights as the index.
When you can invest in a comparison metric (index), it becomes a benchmark. You can get the combined return of all investors together, by investing in the benchmark index.
Going back to the main question — the NIFTY provided over 30% returns in the last three months. So, should your investments have done the same?
Yes, if you had three things:
Only stocks in your portfolio
Only stocks in the NIFTY 50 index
All stocks in the same weights as the NIFTY index
or, if you only had the benchmark index — a NIFTY Index Fund.
Unlike equity, most other asset classes have only comparable metrics — not indices or benchmarks. For example, we use inflation to compare fixed-income investments. But, how do you compare overall return?