Customized Benchmark: What Is Required To Calculate The ITA Index?

Windmill in Amsterdam

Windmill in Amsterdam

Long-time readers know the importance of benchmarking a portfolio, but some investors may not know what is required to calculate the ITA Index.  Understanding how to use the TLH Spreadsheet is at the core of calculating the ITA Index.  Assume you are constructing a portfolio using sixteen different classes.  Here is a list similar to what I use in nearly every portfolio.  I’ve included the critical ticker for each asset class.

  • Large-Cap Blend (VTI)
  • Large-Cap Value (VTV)
  • Mid-Cap Value (VOE)
  • Small-Cap Value (VBR)
  • Large-Cap Growth (VUG)
  • Mid-Cap Growth (VOT)
  • Small-Cap Growth (VBK)
  • Bonds and Income (BND)
  • Developed International Markets (VEU)
  • Emerging Markets (VWO)
  • U.S. Real Estate (VNQ)
  • International Real Estate (RWX)
  • Commodities (DBC)
  • International Bonds (BWX or PCY)
  • Precious Metals (GTU or GLD)
  • Cash

All of these Exchange Traded Funds (ETFs) with exception of DBC, GTU, and GLD are commission free if you are a client with TDAmeritrade.  Otherwise the commission is $7.00 per trade.  Be sure to negotiate with TDAmeritrade for the $7.00 rate as that is not automatic.  At least it was not a few years ago.  If you are with Fidelity or another discount broker, select commission free ETFs that represent the asset classes you want to include in your portfolio.

After you determine the asset classes to include in the portfolio, invest 5 shares in each of the above sixteen (16) ETFs.  Once this is accomplished you are ready to begin a calculation of the ITA Index, provided you know how to use the TLH Spreadsheet.  Platinum members have access to a number of “Camtasia” audio/video help sessions.  If there is something you don’t understand or I was not complete in one of the “Camtasia” sessions, I will develop a new “Camtasia” to help you over the hump.

For more information on the importance of benchmarking a portfolio, go over to the right-hand sidebar and under Categories select the option, Benchmarks.  You will find a number of posts on this important, but frequently neglected, topic.


My Portfolio Is Performing Great. Really? How Do You Know?

One comment I frequently hear when folks talk about investments is the following. “My portfolio is performing great.” This statement conjures up questions I rarely ask as it tends to put the investor on the spot. Here are a few question that run through my mind.

  • Performing great with respect to what?
  • When was the portfolio launched?
  • Is the portfolio return calculated by an acceptable method?
  • Is there a benchmark for the portfolio and if so, what is it?
  • Is the benchmark appropriate for the portfolio?
  • What risk is involved and how is the risk measured?

Nearly fifteen years ago I was involved in an interesting Internet discussion where the author of an investment book and associated software made the claim as follows. If one followed the advice of his software one could reach an annualized return of 15% per year. Rather a heady statement. One needs to recall this discussion began in the late 1990s when the U.S. Equities market was particularly hot.

As an owner of this software I was interested in the claim and took up the challenge. I agreed to set up a portfolio of no trivial amount and I would precisely follow the signals of the software program for five years as the portfolio should double over that period. The bet was accepted. I figured I was a winner both ways. If the portfolio doubled, I could easily afford to pay off as a loser and if the portfolio did not meet the 15% annualized return, I would win the bet. As it turned out, I won the bet as the software program fell short of returning 15% per year, but the portfolio actually outperformed both the VTSMX and VFINX index funds, the two used as benchmarks for this portfolio.

While I had several commercial programs available to track the Internal Rate of Return (IRR) of the portfolio, none of these programs had the capability of tracking a benchmark such as the S&P 500 (VFINX) or the total U.S. Equities market (VTSMX). While one commercial program claimed to accurately track an index such as the VTSMX, I was able to show that the program did not correctly track cash flowing in and out of the portfolio. Two other commercial programs paid no attention to benchmarks. Tracking the performance of a portfolio without an acceptable benchmark is akin to high jumping without a bar.

The discussion and debate over performance and doubling the portfolio in five years was taking place over the Internet and as a result a commercial portfolio tracking company took up the challenge to develop several benchmarks one could use to track portfolios. They got it right.

In addition to the commercial company getting involved, a bright Excel programmer coded a spreadsheet that eventually evolved into the TLH Spreadsheet. This spreadsheet calculates both portfolio performance (tested for accuracy against three commercial programs), four benchmarks, and includes several portfolio risk calculations. One of the benchmarks (ITA Index) is customized to the strategic asset allocation plan for the portfolio.

To understand what is meant by “my portfolio is doing great” one needs to consider a number of questions and it involves more than just avoiding loss of money, although that too is very important.

PS  Without benchmarking we would not have a clue as to how well the Momentum-Optimization Model is working.

Portfolio Performance and Benchmarks

Grand Tetons National Park

Grand Tetons National Park

A few days ago there was a brief discussion concerning portfolio performance as it related to the ITA portfolios.  The question raised was, why are so many ITA portfolios lagging the VTSMX index fund?  The fundamental answer is that the VTSMX is not an appropriate benchmark unless the portfolio is only made up of U.S. stocks.  Note that VTSMX is comprised of stocks in the U.S. Equity market where approximately 80% are large-cap stocks and the rest a mid- and small-cap stocks.  VTSMX does not contain bonds, REITs, commodities, or international stocks.  I’ve long maintained that the S&P 500 is not an appropriate benchmark for most portfolios unless the portfolio is made up of large-cap U.S. stocks.  Nevertheless, it is not uncommon to see the S&P 500 used as a portfolio benchmark.  While the VTSMX is an improvement as a benchmark, it is still inappropriate for portfolios world wide diversification.  For example, as soon as bonds are part of a portfolio, benchmarks such as the S&P 500 and VTSMX are not appropriate.  This is why so much attention is given to the ITA Index, our customized benchmark.

In one of William Bernstein’s books he details the performance of one famous money manager, where in order to outperform the S&P 500 he invested in international stocks.  The international market took off.  VGTSX was the appropriate benchmark for the international portfolio of the portfolio, not VFINX or the S&P 500.  This brings me to another important point.  The benchmark needs to be an investable security such as VFINX, VGTSX, or VTSMX.

Here is a critical blog entry explaining the ground rules for developing a benchmark.  For more information on my philosophy surrounding benchmarks, go to the Categories sidebar and pull down Benchmarks.  Begin reading that material and you will find many arguments in favor of a benchmark such as the ITA Index rather than VTSMX.

Examples frequently explain logic better than verbiage.  Assume one had a portfolio that was 50% stocks and 50% bonds.  If the portfolio grew 6% in one year and we found the VTSMX increased 8% and a total bond index such as VBMFX increased by 3% one can conclude that the portfolio manager added value since (8% + 3%)/2 = 5.5%.  Granted, the portfolio lagged the VTSMX index fund, but that can be explained by the asset allocation plan of the portfolio.

Even though the ITA Index is a major advancement as a benchmark, it is far from perfect.  Here is an example of one weakness.  The other day I made a change in the Strategic Asset Allocation of one ITA portfolio.  I shifted an allocation of bonds into U.S. Equities.  As a result of this shift I increased the performance of the ITA Index since U.S. Equities are performing much better than bonds.  This shift immediately made it more difficult for the portfolio to beat the customized ITA Index benchmark.  Were the allocation plan to shift from equities to bonds, it would make it easier for the portfolio to beat the ITA Index benchmark.

Benchmarking a portfolio is not a simple task.  My goal is to do it as honestly as I know how.  With the affordable tools at hand, the best method I’ve come up with is built into the TLH Spreadsheet and it is the ITA Index.



Revisiting the ITA Index

Long-time readers of ITA are aware of ITA Index, our customized benchmark.  Why use a benchmark such as the ITA Index?  While we watch the performance of VTSMX, an index fund that covers the entire U.S. Equities market, it is not an appropriate benchmark if one holds assets outside the U.S. Equities market.  Emerging markets is an example.  For this reason, I came up with a way to measure the performance of a portfolio that holds a variety of asset classes.

To use the ITA Index one must first lay out a Strategic Asset Allocation (SAA) plan.  For example, suppose we hold the following asset classes and the associated percentage in each.


  • U.S Equities = 30%
  • Developed international markets = 15%
  • Emerging markets = 5%
  • Domestic REITs = 20%
  • Bonds and Treasuries = 30%

The benchmark for U.S. Equities is VTSMX or VTI.  Therefore, one of our holdings will be VTI in the portfolio and 30% is multiplied by the IRR for VTI or VTSMX giving us that performance percentage of the portfolio.

Since developed and emerging markets are both international, I use VGTSX as the benchmark.  I could split these asset classes, but that is not necessary unless one wishes to fine tune the ITA Index.  Twenty percent (20%) of the performance of VGTSX is added to the above 30% calculation.  In this example we have accounted for 50% of the portfolio.

We are left with two more asset classes in this example.  For a REIT benchmark I use VNQ.  To calculate this portion of the ITA Index I multiply 20% times the IRR performance of VNQ and then add it to the above 50% calculation.

For the last asset class, bonds and treasuries, I use Vanguard’s Total Bond ETF, BND.  Thirty percent (30%) of the IRR value of BND completes the asset calculations.  I add this product to the above 70% to complete the ITA Index calculation.

All this is build into the TLH Spreadsheet, although each user will need to customize the calculations to meet the SAA portfolio plan as each portfolio is different.

If you have specific questions related to calculating the ITA Index, please ask.


Closer Examination of the ITA Index

What are the weaknesses in the ITA Index?  While the ITA Index is a major step forward in meeting all the qualifications of portfolio benchmarking, it does contain flaws.  The concept is sound, but the way it is handled within the TLH Spreadsheet is not completely accurate.  To understand the weaknesses requires the reader to “get into weeds” of the details of how the Internal Rate of Return (IRR) is calculated for the three primary indexes.  Those indexes are:  VFINX, VTSMX, and VGTSX.

[Read more…]

Benchmarking the Portfolio

Benchmarking Portfolio

Establishing an appropriate benchmark for a portfolio is essential if one is serious about investing. Avoiding portfolio benchmarking is an act of self-deception. Exactly what is the purpose of a benchmark and what are the requirements for a fair and reasonable benchmark. Here is one definition of benchmarking.


In the investing world, the S&P 500 is frequently used as a benchmark for portfolios made up of U.S. Equities. Even though the S&P 500 is a common benchmark, it is not the most appropriate and it does not satisfy all benchmark requirements listed below.

1. The benchmark must be investable. If one is using the S&P 500 as the benchmark, then an investable vehicle is the VFINX index fund as it closely tracks the performance of the S&P 500.

2. The benchmark must be identified in advance. It is unfair to set up a benchmark after the fact so the portfolio shows up better with respect to the benchmark.

3. The benchmark must be objectively constructed. Many investors will use a simple benchmark such as Vanguard’s Total Market Index ETF, VTI or the index fund, VTSMX. These are certainly objective benchmarks as one can easily understand their construction. It becomes more difficult to meet this requirement when one begins to put together a customized benchmark. The TLH spreadsheet (available to Platinum subscribers) is set up to build customized benchmarks unique to individual portfolios.

4. A good performance benchmark has an unambiguous composition. Here at ITA Wealth Management, our customized benchmarks (unique to each portfolio) are all built around well established ETFs.

5. A good performance benchmark is easily measured. This requirement is satisfied within the TLH Spreadsheet.

6. A strong portfolio tracking tool provides the user with a means for measuring portfolio risk. Here again, we strongly recommend using the TLH Spreadsheet as it not only measures portfolio risk, but does it using a semi-variance calculation instead of the less meaningful mean-variance calculation.

Why do investors avoid portfolio benchmarking? 1) It takes time to learn, understand, and implement. Most investors do not have the time or inclination to set up portfolio benchmarks. 2) There are few affordable tools available for the small investor to adequately benchmark their portfolio. Even the affordable commercial programs have gaps when it comes to meeting the above standards. 3) Investors do not want to know the truth about the performance of their portfolio. 4) Other investors insist in setting up their own standards of portfolio evaluation, well outside the accepted standards of the industry. 

Platinum members are highly encouraged to use the TLH Spreadsheet to track, benchmark, and measure the risk of their portfolios. Numerous video/audio clips are dotted throughout this blog as aids in learning how to use the spreadsheet. New investors just starting out are highly encouraged to get started right with it comes to portfolio management.


Photograph: Mykonos Island, Greece

ITA Index: Preparation For Calculation

If you are interested in comparing the Internal Rate of Return of your portfolio vs. a customized benchmark, then consider using the ITA Index which is part of the TLH Spreadsheet.  Using the S&P 500 (VFINX) or the total market index (VTSMX) focuses too much on the U.S. Equities market.  Neither is an appropriate benchmark for most portfolios.  To benchmark properly, one need to include asset classes that are part of the portfolio.  These additional asset classes likely include bonds, real estate, and international markets.  In most of our portfolios, commodities and international bonds are also part of the Strategic Asset Allocation (SAA) plan.

Setting up the ITA Index is not all that difficult, but we need to hold index funds in all the asset classes so we can make the necessary calculation.  If you are using the “Big Six” or “Big Nine,” all investments in those asset classes can be benchmarked by using the VTSMX as it includes stocks in all the various cap sizes.  The “Big Nine” include: VTI, VTV, VOE, VBR, VO, VB, VUG, VOE, and VBK.  If you hold IWN or DVY, those would also be benchmarked using the VTSMX.

I benchmark VEU, VEA, and VWO against the VGTSX index.  For most portfolios, about 50% of the portfolio is benchmarked against VTSMX and VGTSX.  That leaves bonds, real estate, international REITs, international bonds, and commodities.  What does one use as an index for each of these asset classes?  Here are my suggestions.

Domestic REITs:  VNQ

International REITs:  RWX

Commodities:  DBC

International Bonds:  PCY or BWX

Domestic Bonds: BND or AGG

Cash: I generally lump cash in with domestic bonds or use TIP as the index.  This is only 1% of the portfolio so it is not a big issue.

To calculate the ITA Index requires the manager to hold at least one share in each of these ETFs at all times so the performance of the index can be calculated.  If you allocate 5% to commodities, then 5% (0.05) is multiplied by the performance of DBC.  Platinum members can see how the calculation is performed by sitting on the ITA Index performance cell in the TLH Spreadsheet.

Since the Schrodinger is one of the older portfolios tracked by the TLH Spreadsheet, the VGTSX index is not included.  That is why I recommend potential TLH Spreadsheet users begin with the Gauss as it includes all the latest features.

For further hints on portfolio benchmarking, check all the benchmark blog entries under Categories.  Here is one benchmark link to get you started.


TLH Spreadsheet: Why It Is Useful For Serious Investors

Platinum members new to ITA Wealth Management should not overlook the power of the TLH Spreadsheet.  Successful investing is all about portfolio planning, construction, and monitoring.  The TLH Spreadsheet is an aid in all three categories.  Here are several benefits investors derive when using this portfolio tracking spreadsheet.

1. Construction and ease of tracking Strategic Asset Allocation plan.

2. Data table that shows how many shares of a particular ETF are required to bring the asset class back into balance.

3. Ability to establish variable asset target bands.

4. Correct calculation of Internal Rate of Return (IRR) for both portfolio and several benchmarks.

5. Option to build customized benchmark.

6. Tracks three risk monitoring ratios.  They are:  Information Ratio, Sortino Ratio, and Retirement Ratio.

7. Automatic updating of price data.


Camtasia audio/video helps are available to help interested users gain comfort with the TLH Spreadsheet.  Model portfolios are available to Platinum members.

Photograph:  Mt. Hood taken by Lin Rush

Creating The Customized ITA Index Benchmark For The Kenilworth And Other Portfolios

Constructing a customized benchmark to use as a performance standard is nearly as important as putting together a Strategic Asset Allocation (SAA) plan for a portfolio.  If one does not benchmark a portfolio how is it possible to know how well the portfolio is being managed?  To understand what is required to come up with a good benchmark, check this reference.  I also recommend reviewing the benchmark blogs by going over to the right-hand side bar and clicking on Categories.  Then select Benchmarks. 

I will use the Kenilworth to illustrate how the ITA Index customized benchmark is constructed for this particular portfolios.  Thirty percent (30%) of the portfolio is allocated to U.S. Equities.  This 30% is spread out over different cap sizes and investment styles.  The benchmark for all these different asset classes is the VTSMX index fund from Vanguard.  It is a total U.S. market index so it serves as the benchmark for 30% of the Kenilworth.  Twenty-five percent (25%) of the Kenilworth is devoted to international markets.  Part is allocated to developed markets and another piece is placed in emerging markets.  The benchmark for all international equities is the VGTSX global index fund.  We have now assigned 30% to VTSMX and another 25% to VGTSX.  That leaves 45% for alternative benchmarks.

The customized benchmark (ITA Index) is compromised slightly at this point.  For example, 19% is allocated to bonds and income.  I use BND as the benchmark for 20% of the portfolio as this includes the 19% allocated to bonds plus 1% held in cash.  The BND is not a perfect benchmark, but it is much better than simply lumping the entire portfolio under a commonly used benchmark such as the S&P 500.  The S&P 500 makes no sense as a benchmark for a portfolio holding international REITs, commodities, bonds, emerging markets, etc. 

We now have 75% of the portfolio benchmarked between three index vehicles.  How do we handle the remaining 25%? The last 25% of the portfolio is broken down as follows.  Ten percent (10%) is allocated to domestic REITs and 5% to international REITs.  Since I use VNQ to cover domestic REITs, VNQ becomes my benchmark.  RWX serves as the benchmark for the 5% allocated to international REITs.  The final 10% of the Kenilworth is divided equally between commodities (DBC) and international bonds (PCY).  PCY is actually an emerging markets sovereign debt ETF.  I use PCY as a proxy for the international bond allocation.  DBC and PCY are the final two pieces to putting together the ITA Index, the customized benchmark for the Kenilworth portfolio.

While the ITA Index is not a perfect customized benchmark, it goes a long way toward helping the portfolio money manager know how well the portfolio is performing when measured against this particular index.  As shown in an earlier post, the IRR value for the Kenilworth is almost exactly equal to the ITA Index.  This indicates the manager of the Kenilworth is keeping the portfolio in balance with respect to the Strategic Asset Allocation plan.  When the IRR of the portfolio gains ground on the IRR of the ITA Index, the improvement is due to making correct Tactical Asset Allocation (TAA) moves as called for by the ITA Risk Reduction (ITARR) model.  When the IRR of the portfolio falls below the IRR of the ITA Index, the money manager is not making correct TAA calls or the ITARR model is not working properly.

Every portfolio calls for a benchmark.  The ITA Index is an effort to measure portfolio performance against a fair standard.

What Is A Good Sortino Ratio?

Seeking a Good Sortino Ratio

A reader of ITA Wealth Management was seeking an answer to the question, what is a good Sortino Ratio?  The simple and quick answer is – anything above zero.  Check this definition of the SR.  While the equation is quite simple, the difficulty comes in calculating the denominator.

SR = (P – T)/DR where

P is the portfolio return

T is a portfolio target.  One might use a 90-Day T-Bill or some benchmark such as the VTSMX index fund or the ITA Index, our customized benchmark.

DR = Downside Risk     This calculation is built into the TLH Spreadsheet, but one needs to learn how to maintain the calculation.  All this is available to Platinum members.

To come up with good Sortino Ratio, one needs a positive value in the numerator of the SR equation.  This requires the portfolio to perform better than T, whatever one chooses for this value.  While I track the Sortino Ratio, my preference is to use the Retirement Ratio as it sets a higher standard.

For further information, search for Sortino on this blog.