Business, Legal & Accounting Glossary
A benchmark is a reference point against which other data are compared. For example, the S and P 500 index is a commonly used benchmark for the performance of many mutual funds that invest in common stocks.
A standard or point of reference against which things may be compared or assessed
A benchmark is a security or index against which the performance of other securities is judged. A benchmark is a goal to meet or to beat. Many investors use the S&P 500 Index as a benchmark for the US stock market. Their goal is for their investments to beat this benchmark. If their investments return more than the S&P 500 then the investor will have beaten the benchmark — if the investor’s efforts fall short then the investor will have failed to meet the benchmark. Investors may use any security or index as their benchmark. The theory is, if an investor’s efforts don’t at least equal the return provided by the benchmark, then the investor would be better off simply investing in the benchmark itself.
When calculating the rate of return of your (or others’) portfolio, you can always say “I made 23% in 2003!” That’s great, but the overall market made 26.4% that year, so you kind of fell behind, didn’t you? I mean, you could have invested in the S&P 500 on Dec 31, 2002, and sold on Dec 31, 2003, and made over 26% on your money. Instead, all you got was 23%.
This is an example of using a benchmark. It compares how you did against some recognizable standard. If you beat the standard, all kudos to you. But if you trailed it, well, better luck next time.
Of course, you shouldn’t look at just one year’s worth of returns, but the average returns over a longer time period. You could have been a bit off your game in 2003. In 2004, though, you made 30% while the S&P 500 only did 9.0%. Wow! And over that 2-year period? You did 59.9% overall, versus just 37.8% for the S&P 500. Yay, you!
On an annual basis for those two years, you did 26.4% per year on average, while the S&P 500 did 17.4%. Yay, you, again!
The benchmark, however, should be relevant. If you invest only in large-cap companies, for instance, then the S&P 500 or the Russell 1000 are decent choices, while the small-cap Russell 2000 would not be a good choice. That would be like comparing the performance of a black lab against that of a Scotty terrier. Just wrong.
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This glossary post was last updated: 4th August, 2021 | 8 Views.