A benchmark is a standard against which the performance of an investment – such as a stock, bond, or mutual fund – can be compared. We frequently use stock and bond indices as benchmarks.
When you hear about an investment “beating the market”, that means it is generating returns that exceed its relevant benchmark.
Indices as Benchmarks
Investors often use an index as an investment benchmark. An index is a measurement of the performance of a basket of stocks, bonds, or other securities in a particular asset class. You cannot invest in an index as it simply tracks the performance of its constituents, but there are mutual funds and exchange-traded funds (ETFs) that mirror the performance of major indices.
For large-cap American stocks, the most commonly used benchmarks are the Dow Jones Industrial Average and the S&P 500. Interestingly, the Dow Jones represents only 30 companies, while the S&P 500 tracks 500 companies. Yet the historical performance of these indices has largely been the same. The NASDAQ Composite is another popular U.S. stock index. It is weighted heavily toward information technology companies.
The U.S. bond market frequently uses the Barclays Capital U.S. Aggregate Bond Index as a benchmark.
When looking to foreign markets, medium and large-sized companies commonly use the MSCI EAFE Index as a benchmark across the developed world.
Why Benchmarks Matter
Since a benchmark gives an approximation of the average performance of an entire asset class, a benchmark can easily help identify whether a particular security is leading, lagging or somewhere in the middle. Simply compare the historical performance of the security with that of its benchmark.
Among mutual fund and ETF investors, index funds – which mirror the performance of a specific index – are becoming increasingly popular. More traditional and active investing styles – which incur higher costs – have been lagging index funds for the past few years. As a result, many people are now deciding to follow the market rather than trying to beat it.
Benchmarks in Retirement Planning
A benchmark can be a helpful tool to determine if your retirement planning strategies are on track. Compare the performance of your retirement savings portfolio to a benchmark that best represents your asset mix. If you are lagging the benchmark, it may be time to adjust your allocations.
With the rise of index investing, it’s easier than ever to manage your own portfolio and know that your money will at least grow at the rate of the market. Many people still find it useful to let a financial advisor do the work, though.
If you’re considering enlisting the help of a financial advisor to help you plan for retirement, ask the advisor how their investment strategies have historically stacked up against market benchmarks. That will determine the value of their advisory services.
