Glossary
Benchmark
A standard, usually an index, against which the performance of a portfolio, fund or manager is measured.
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A benchmark is a reference point, almost always a market index, used to judge how well an investment, fund or portfolio has done. Saying a fund returned 9% last year means little on its own; saying it returned 9% while its benchmark returned 11% tells you the manager trailed what you could have earned with a simple index fund. Benchmarks turn absolute numbers into relative ones.
How a benchmark is chosen
A fair benchmark holds the same kind of securities, with similar risk, that the portfolio could own:
- A large-cap US stock fund is usually compared with the S&P 500.
- A small-cap fund with the Russell 2000.
- A technology-heavy growth fund with the Nasdaq-100 or a growth index.
- A bond fund with a broad investment-grade bond index.
- A 60/40 portfolio with a blend: 60% of a stock index plus 40% of a bond index.
Fund prospectuses must show performance against a broad-based market index, and many funds also choose a narrower one.
Pitfalls
- Benchmark shopping. Managers sometimes pick the easiest benchmark to beat. Check that it matches what the fund actually holds.
- Price versus total return. Compare total-return figures on both sides, since a price-only index ignores dividends.
- Risk. Beating a benchmark by taking far more risk is not the same as skill, which is what measures like alpha try to capture.
For personal investors, a benchmark is also a sanity check: if your stock picks have trailed a cheap index fund for years, that is worth knowing.