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Get Off the Bench: A Look at Benchmarks


How are you doing? For investors, a better question might be: How are you doing against a benchmark?

Benchmarks, such as the Dow Jones Industrial Average, S&P 500 and Russell 2000, are indexes or averages that track a particular stock market or market segment. There are similar benchmarks for bonds, such as the Bloomberg U.S. Aggregate Bond Index or the S&P Municipal Bond Index.

Benchmarks play a valuable role for investors, providing a standard against which to measure an investment’s performance. Weighing the return on a particular stock, bond, mutual fund or exchange-traded fund (ETF) against a comparable benchmark can help investors make more informed decisions on how to invest.

Putting Benchmarks to Use

Let’s say a fund you own had an average annual return of 10 percent over the last five years. Sounds good, right?

But if a comparable benchmark returned 12 percent annually over the same period, then your fund’s performance lagged. On the other hand, if the benchmark index only returned 8 percent over the last five years, that means your fund exceeded its benchmark.

If a fund tends to lag its benchmark year after year, you might need to dig a little deeper to determine if the fund is the best for you and your investment needs. After all, there’s more to the story than just whether a fund is outperforming or lagging its benchmark.

You’ll want to consider also how much risk your investment is assuming relative to the benchmark. For example, if the fund is underperforming relative to its benchmark but is doing so because it’s taking on less risk, it might still be a good fit for your portfolio. Fund performance data often includes both returns and a standard deviation of returns, which can help you judge how much risk is involved.

One of the challenges that portfolio managers face in providing stronger-than-benchmark returns is that their funds' performance needs to compensate for their operating costs. The returns of actively managed funds are reduced by the cost of hiring a professional fund manager, the cost of buying and selling investments in the fund, and by other costs such as accounting expenses and distribution fees.

Suppose, for example, that the management and administrative fees of an actively managed fund are 1.5 percent of the fund's total assets and the fund's benchmark provided a 9 percent return. To beat that benchmark, the portfolio manager would need to assemble a fund portfolio that returned better than 10.5 percent before fees were taken out. Anything less, and the fund's returns would lag its benchmark.

You can use FINRA’s Fund Analyzer to determine how much you can expect to pay in fees and expenses for a mutual fund or ETF.

Generally, Compare Apples to Apples…

It’s important to choose the appropriate benchmark as a point of comparison. For instance, if you’re evaluating a large-capitalization U.S. stock mutual fund, then the S&P 500, which tracks large U.S. stocks, could be a relevant benchmark. Conversely, an appropriate benchmark to use when looking at a U.S. small-cap fund might be the Russell 2000, which measures the small-cap segment of U.S. equities.

A fund’s quarterly report will often tell you what specific index the fund is benchmarked against—and how the fund performance stacks up. If you’re looking at an individual stock, then a benchmark that tracks a particular industry might be your best bet.

Be sure to review what assets the benchmark tracks to understand how it compares, or possibly contrasts, with your investments.

…But Know When to Compare Apples to Oranges

There might be times that you’d want to measure your investment performance against a benchmark that isn’t comparable. For example, if you’re thinking about changing your investment strategy, you might want to compare the returns of your current portfolio to a benchmark that mirrors the portfolio strategy you’re thinking about.

Benchmark Comparisons Are Not Crystal Balls

Keep in mind, benchmark comparisons show how an investment measures up against a benchmark in the past. But there’s no guarantee that a benchmark, or an investment you’re evaluating, will perform similarly in the future.

A good rule to follow is to do your comparisons over a long period of time—several years—as opposed to a single quarter or even a full year. Short-term comparisons can be skewed by one-time events that alter the performance of the benchmark or the investment under consideration.

Learn more about evaluating the performance of your investments.