The S&P 500 is comprised of American companies that have common stock listed on the NYSE or NASDAQ. It is a weighted index, meaning that the larger the market capitalization of a company, the more weight it carries in the index. Many people consider it the best representation of the U.S. stock market, although I would argue that it has a lot of bias toward large cap stocks. The market cap of the companies in the index must be greater than $5.3 billion, so many small cap stocks are immediately ruled out.
So my question is why do we keep comparing every available investment portfolio to the S&P 500? On one hand, I can see the rationale. 100 years ago, there were not many investments options available to investors. Because the S&P 500 was (and is) considered the best representation of the U.S. stock market that we have, clearly this should have been the comparison back then. We all got used to it, and kept comparing our portfolios to it. However, the world of retail investing has changed dramatically today. The average investor is has almost the entire world of investments available to them at a reasonable cost. Almost no one puts all of their investments into a single asset class these days, so why are we comparing all of our investments to a single asset class?
If you are a stock-picker who focuses on domestic common stock, and are usually 100% invested, then I would say that the S&P 500 is the right benchmark for you to compare to. But what if you have a portfolio that is 60% domestic stock, 20% international stock, and 20% bonds? In theory, this portfolio should have a lower risk profile than the S&P 500. So does it make sense to compare on performance, without adjusting for risk? I would argue that it doesn’t make sense at all, and that you instead, you may want to use a weighted benchmark of your own for comparison. Take the S&P 500 performance for the time period and multiply it by 0.6, then find an international index that represents your holdings and multiply the performance by 0.2, and do the same for a representative bond index, and add those three numbers together. That will give you a much better benchmark for your diversified portfolio.