A group of securities used for comparison when evaluating the performance of a mutual fund or portfolio. Benchmark Index is typically a standard and unmanaged index used to gauge the performance of other equities or securities on the market. Benchmark indices include the Dow Jones Industrial Average, the S&P 500, or the Russell 2000.
Understanding Benchmarks
The performance of a stock, fund, or any other investment of the same industry and composition can be measured against market benchmarks, which are indexes comprised of several securities, assets, or instruments.
All different kinds of asset classes have their own respective benchmark indexes. In the equities market, some of the most widely used benchmarks are the S&P 500 and the Dow Jones Industrial Average, both of which measure the performance of large-capitalization stocks.
Share Price Indices
Standard & Poor's is responsible for constructing the S&P 500. It tracks the performance of the top 500 stocks on the U.S. stock market by including them in an index based on a set of criteria and valuation procedures.
The 30 stocks that make up the Dow Jones Industrial Average are all widely known and respected brands operating in the United States.
The S&P 500 has a much larger number of equities compared to the Dow Jones, but also widely known name, such Apple, Boeing, Caterpillar, General Electric, Goldman Sachs, Google, Microsoft, Procter & Gamble, and others. Although they each only include a small percentage of all equities traded on public exchanges, both of these indices are widely used as proxies for the whole stock market.
Fixed Income Index
Investors utilize fixed income assets like bonds and treasuries to generate income or to protect their wealth from a declining market, and fixed income indexes track how those assets perform.
The Bloomberg Aggregate Bond Index and the Bloomberg Capital U.S. Corporate High Yield Bond Index are all excellent examples of benchmarks for fixed income.
Making Use of a Benchmark
Assessing the success of a portfolio requires a comparison to a standard that is indicative of the particular market segment, industry, and/or economy to which the portfolio belongs. That's where the benchmark index come into play. However if your investments are spread out throughout various sectors, you might not be able to use a single index to judge the performance of your portfolio as a whole.
Based on the Preexisting Data
Individual equities are not typically used in the portfolio construction process for retail investors. Although it's not impossible to do so, many investors find the time and effort required to research stocks and then buy only those that fulfill their requirements to be too great. Thus, many investors opt for mutual funds or ETFs that track the movements of several indices.
Those who have a fund or multiple funds in their portfolio can use the data already provided by fund managers to examine how their holdings are performing relative to the benchmarks they are supposed to imitate.
Conclusion
The value of market benchmarks lies in the fact that they provide investors with a standard against which the performance of their holdings can be measured. In addition, benchmarks show the state of a market, allowing you to assess the overall health of the equity market or the performance of a specific asset class. Changes in investment practices and investor attitude lead to the introduction of new market benchmarks, which in turn influence subsequent changes in the benchmarks themselves.
The one drawback of using benchmarks is that they only reflect past performance; future results for the investments that make up an index cannot be predicted. You are limited to viewing the outcomes of your investments, which is to your benefit because you may use this data to modify or refocus your approach.