The Enlightened Investor: What is meant by “market return”?

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The investment industry and media often refer to the “market” and the “market return”.

Or that the market was up or down on the day and that a portfolio manager’s return outperformed or underperformed the market return. So what exactly do they mean and how does it relate to you?

The market generally refers to the publicly listed securities available within a specific asset class. For example, there are over 1,000 Canadian companies whose stocks can be purchased on the Toronto Stock Exchange. This is the Canadian stock market. The collective value of these stocks on the last day of the year relative to the first day produces a positive gain or a negative loss. This is the market return. This of course is true of other asset classes such as bonds, US stocks, or real estate.

More commonly the “market” refers to a commercial index consisting of sampled securities from a particular asset class versus all of the securities. The S&P TSX Composite index is comprised of 235 Canadian companies drawn from 10 distinct industries whose collective risk and return is a proxy for all the securities in the Canadian stock asset class. Through time the increase or decrease in the value of the S&P TSX Composite Index provides us with the Canadian stock market return.

So, most often when you turn on the TV and they say the Canadian stock market is down they are referring to a decline in value of the S&P TSX Composite Index. When you hear that a portfolio manager has “beaten the Canadian stock market return” it means they have chosen a portfolio of stocks that is different than the index holdings and has a higher return.

You can achieve the market return for each asset class by investing in an index fund or exchange traded fund (ETF) that has the same holdings as the underlying commercial index. For example, the Vanguard FTSE Canada All-Cap Index ETF is comprised of 234 Canadian companies that are virtually identical to the 235 Canadian stocks included in the S&P TSX Composite Index. Thus the index fund (ETF) mirrors the risk and return of the Canadian stock market.

Investors who buy individual stocks for their portfolio versus buying an ETF rarely have anywhere near 235 stocks in total let alone per asset class. This most likely means they lack diversification and are taking more risk than needed. And does the hand picked stock portfolio generate a return that is greater than the market return? If not, wouldn’t you be better off just buying an index fund? In other words, “if you can beat the market return, great! Do that. If not, then index!”

If you would like more information or have any questions, feel free to contact us at 780.466.6204, or click here to send us an email.

Thanks to Chris Turnbull of The Index House for providing this article.

The Index House is a division of Polaris Financial Inc.

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