Benchmark

Loading the player...

What is a 'Benchmark'

A benchmark is a standard against which the performance of a security, mutual fund or investment manager can be measured. Generally, broad market and market-segment stock and bond indexes are used for this purpose.

BREAKING DOWN 'Benchmark'

When evaluating the performance of any investment, it's important to compare it against an appropriate benchmark. In the financial field, there are dozens of indexes that analysts use to gauge the performance of any given investment including the S&P 500, the Dow Jones Industrial Average, the Russell 2000 Index and even competitor funds. Mutual fund investors may use Lipper indexes, which use the 30 largest mutual funds in a specific category, while international investors may use MSCI Indexes. 

Setting a benchmark can help an investor communicate with their portfolio manager what they’re hoping to achieve with their investment, so that the portfolio manager will make decisions with the investor's goals in mind. While a benchmark can help a portfolio manager, it’s important that the benchmark being set is right for the investors goals. 

An investor's benchmark should reflect the amount of risk he or she is willing to take, the amount to be invested, and the cost the investor is willing to pay. A benchmark should also mirror the investment style of the portfolio. As stated above, mutual funds, international investors, and other investors use different indexes as benchmarks for their investment portfolios because the type of investments they’re making are of a different nature. Some portfolios are hard to find benchmarks for, like real estate portfolios, where each investment is different in nature.

Some managers seek simply to meet benchmarks, while others work to beat them. While beating a benchmark can make investors happy, providing too much of an incentive to do so can force a manager to take undue risk with a portfolio. 

Passive or Active Management

Disagreements about the value of benchmarks can in some ways be chalked up to a difference in fundamental questions about management style. Managers who subscribe to the Efficient Market Hypothesis (EMH) claim that it is essentially impossible to beat the market, and then by extension, the idea of trying beat a benchmark isn’t a realistic goal for a manager to try and meet. Nonetheless, active managers who manage to beat benchmarks do enjoy a certain loyalty from investors despite the difficulties of replicating those types of returns on a regular basis. 

History of the Term

The term ‘Benchmark’ has its etymological roots with cobblers who used it in reference to the measure of a persons foot for shoes. The measurement was usually taken by placing the customers foot on a bench and making marks in order to take the measurement. 

RELATED TERMS
  1. Active Risk

    A type of risk that a fund or managed portfolio creates as it ...
  2. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's ...
  3. Active Index Fund

    A type of index fund where a fund manager bases the fund's initial ...
  4. Benchmark Error

    A situation in which the wrong benchmark is selected in a financial ...
  5. Relative Return

    The return that an asset achieves over a period of time compared ...
  6. Closet Indexing

    A portfolio strategy used by some portfolio managers to achieve ...
Related Articles
  1. ETFs & Mutual Funds

    Active Management: Is It Working For You?

    There are guidelines to be followed when comparing an actively-managed investment strategy with a benchmark.
  2. Managing Wealth

    How to Select and Build a Benchmark to Measure Portfolio Performance

    How to select and build a benchmark to measure the performance of your investment portfolio
  3. Managing Wealth

    Is Your Portfolio Beating Its Benchmark?

    Compare portfolio manager performance using the information ratio.
  4. ETFs & Mutual Funds

    5 Ways To Measure Mutual Fund Risk

    These statistical measurements highlight how to mitigate risk and increase rewards.
  5. Financial Advisor

    Should Investors Nix Actively Managed Funds?

    Index fund returns are on a tear but does this mean investors should nix actively managed funds?
  6. ETFs & Mutual Funds

    Passively Managed Vs. Actively Managed Mutual Funds: Which is Better?

    Learn about the differences between actively and passively managed mutual funds, and for which types of investors each management style is best suited.
  7. ETFs & Mutual Funds

    3 Reasons Tracking Error Matters

    Discover three ways investors can use tracking error to measure performance for a mutual fund or ETF, whether indexed or actively managed.
  8. ETFs & Mutual Funds

    PRHSX: T. Rowe Price Health Sciences Fund Risk Statistics Case Study

    Examine the risk metric of the T. Rowe Price Health Sciences Fund. Analyze beta, capture ratios and standard deviation to assess volatility and systematic risk.
  9. ETFs & Mutual Funds

    Your Mutual Fund: It's Riskier Than You Think

    Fund managers often take on more risk than they should, putting business ahead of fund holders' interests.
  10. Trading

    Fund Management Issues

    The quality of management is a key component of a fund's success.
RELATED FAQS
  1. What are the main benchmarks that track the banking sector?

    Read about the most important benchmarks that can be used to track the banking sector, and why banking benchmarks tend to ... Read Answer >>
  2. What should I use as a benchmark for my small-cap stock portfolio?

    When creating a stock portfolio, it is important to have a benchmark against which you can compare your returns. Comparing ... Read Answer >>
  3. How do I grade my financial adviser?

    I have had the same financial adviser for the past 12 years, obviously through some tough financial times. However, I don't ... Read Answer >>
  4. What are the pros and cons of using the S&P 500 as a benchmark?

    Learn about the advantages and disadvantages of using the S&P 500 as a benchmark for portfolio performance, and understand ... Read Answer >>
  5. What does it mean when people say they "beat the market"? How do they know they have ...

    "Beating the market" is a difficult phrase to analyze. It can be used to refer to two different situations:1. An investor, ... Read Answer >>
  6. What are the main benchmarks that track the performance of the financial services ...

    Learn about some of the primary benchmarks utilized by investors and analysts to track the performance of the financial services ... Read Answer >>
Hot Definitions
  1. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  2. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  3. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  4. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  5. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  6. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
Trading Center