What Is a Benchmark?
A benchmark is a standard against which something is compared. Investors use benchmarks to measure the performance of securities, mutual funds, exchange-traded funds, portfolios, or other investment instruments.
Generally, broad market and market-segment stock and bond indexes are used for this purpose—even cryptocurrencies have benchmarks, hallmarking the importance of having something to compare an asset's performance to.
If there is an investment instrument, there is a benchmark to compare it to—learn more about benchmarks and how you can use them to check your portfolio's performance.
- A benchmark is a standard with which to measure performance.
- In investing, benchmarks are generally indexes of investment instruments against which portfolio performance is evaluated.
- Depending on the particular investment strategy or mandate, the benchmark will differ.
- There are benchmarks for every type of investment and strategy.
Why Benchmarks are Important
Market benchmarks are indexes created to include multiple securities, assets, or other instruments to represent the performance of a stock, fund, or any other investment of the same type and composition.
Benchmark indexes have been created across all types of asset classes. For example, the S&P 500 and Dow Jones Industrial Average are two of the most popular large-capitalization stock benchmarks in the equities market.
The S&P 500 was created by Standard & Poor's. It lists 500 companies—there are actually 505 stocks on the index—based on specific metrics and valuation techniques that reflect the best-performing stocks on the stock market (according to the professionals at S&P).
The Dow Jones Industrial Average comprises 30 U.S. blue-chip stocks—the stocks of well-recognized, established, and financially sound companies.
The S&P 500, of course, has many more stocks listed on it than the Dow does, but there are many similar stocks:
- Alphabet (Google)
- Proctor & Gamble
Both of these indexes are used by many to gauge the performance of the stock market as a whole, even though they only represent a fraction of the stocks listed on public exchanges.
Mutual fund investors may use Refinitiv Lipper indexes, which use the 30 largest mutual funds in a specific category, while international investors may use MSCI Indexes. The Wilshire 5000 is also a popular benchmark; it represents all of the publicly traded stocks in the U.S.
Fixed Income Indexes
Fixed income indexes measure the performance of fixed income assets like bonds and treasuries, which investors use for generating income or as a way to preserve capital during falling market conditions.
Some examples of top fixed income benchmarks include the Bloomberg Aggregate Bond Index (known as the Agg), the Bloomberg Capital U.S. Corporate High Yield Bond Index, and the Bloomberg Capital U.S. Treasury Bond Index.
Commodity indexes measure the performance of a basket of commodities. For example, the Bloomberg Commodity Index (BCOM) consists of 23 exchange-traded physical commodities futures. The index measures 21 commodities across five different sectors and acts as an indicator of the performance of the commodities market. The five sectors are:
- Industrial Metals
- Precious Metals
In addition to traditional benchmarks representing broad market characteristics such as large-cap, mid-cap, small-cap, growth, and value, you'll also find indexes based on fundamental characteristics, sectors, dividends, market trends, investing themes, and much more.
Thematic indexes are lists of stocks that meet specific criteria for a theme, such as environmental, social, and governance (ESG) or sustainability.
Using a Benchmark
When evaluating your investment portfolio's performance, it's important to compare it against a benchmark representing the industry, sector, and market segment to which it belongs. However, if your portfolio is diversified, you may not be able to compare the total portfolio against one index—you may need to evaluate it in sections based on how you've allocated your investments.
Using Information Already Provided
Most retail investors don't build their portfolios by choosing individual stocks. However, it is possible to do so—but in many cases, it is simply too expensive and time-consuming to evaluate stocks and purchase the ones that meet your investing criteria. So, many choose mutual funds or exchange-traded funds (ETFs) that mirror the performance of specific indexes.
If you have a fund—or more than one—in your portfolio, you can compare the information fund managers already provide to see how your funds are doing compared to the indexes they mirror.
For example, the Vanguard Mega Cap Growth ETF (MGK) is an exchange-traded fund that tracks the performance of the CRSP U.S. Mega Cap Growth Index. If you had purchased shares of MGK and wanted to evaluate its performance, you'd first find the fund's page on Vanguard's website and locate the "Performance and Fees" tab and ensure "Summary" is underlined by clicking on it. You'll see the following information:
You can see the fund's changes in market price from its inception to the last month's performance and compare it to its benchmark. Then, find the historical volatility and see how the fund's return and risk compares to that of its benchmark:
R-squared measures how closely the fund has tracked its benchmark—in MGK's case, it has very closely matched the returns of its benchmark (a value of 1.0 indicate tracking, while less than 1.0 indicates less tracking).
Beta is a measure of the fund's risk compared to that of the benchmark—again, MGK has matched its benchmark's risk level (again, 1.0 indicates it has tracked, while less or more than 1.0 indicates less or more tracking, respectively).
MGK has historically matched the return and risk of the benchmark index it was designed to track, give or take a few percentage points. However, when compared to the Dow Jones U.S. Total Stock Market Index, MGK has returned less and has slightly more risk.
What Is the Best Stock Benchmark?
The best stock benchmark is an index that matches your portfolio or holdings the closest.
Is the S&P 500 a Good Benchmark?
It is very commonly used, but many more can be used based on how the benchmark is designed. Some widely used benchmarks in the stock market are the Wilson 5000, Dow Jones Industrial Average, and the Russel 2000.
How Is a Benchmark Calculated?
Different indexes use different methods to calculate their performance. For example, the S&P 500 uses a free-float market capitalization method.
The Bottom Line
Market benchmarks are important because they allow investors to compare their holdings' performance against reliable metrics. Additionally, benchmarks indicate the health of a market—you can also see how a particular class is performing or view the equities market performance as a whole. Market benchmarks constantly evolve, with new ones occasionally appearing based on changing investing strategies and investor sentiments.
The one limitation benchmarks have is that they are indicators of past performance—there is no way of knowing how the investments that comprise an index will perform. You can only view the results of your investment decisions—which is a good thing because you can use the information to make adjustments or readdress your strategy.