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

Benchmarks, such as the S&P 500 and Russell 2000, are indexes or averages that track a particular market or market segment.

They play a critical role for investors, providing a standard against which to measure an investment’s performance. Weighing the return on a particular stock, bond or mutual fund against a comparable benchmark can help investors make more informed decisions on how to invest.

While the Dow Jones Industrial Average and the S&P 500 are two of the most well-known benchmarks, there are a multitude of benchmarks for markets in the U.S. and around the world.

Putting Benchmarks to Use

Let’s say a mutual 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, it could be a sign that you need to dig a little deeper to determine if the fund is the best for you and your investment needs. After all, there is 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 it is doing so because it is 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 exchange-traded fund.

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 mutual fund might be the Russell 2000, which measures the small-cap segment of U.S. equities. A mutual fund’s quarterly reports 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 may be times that you would 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 No Crystal Ball

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.

Now that you know what benchmarks are used for, here’s a brief description of four commonly-used investment benchmarks:

S&P 500 As its name suggests, this famous index tracks 500 stocks of large U.S. companies and is often used as a proxy for the stock market overall. The S&P is a “market-weighted” index meaning companies with larger market capitalization have a greater influence. (Market cap is the dollar market value of the outstanding shares of a public company.) The S&P 500 is often used as a benchmark for evaluating large-cap U.S. mutual funds.

Russell 2000 The Russell 2000 measures the performance of 2,000 small-cap stocks and is a popular benchmark for small-cap mutual funds. It is actually a subset of the Russell 3000, a broader index composed of 3,000 of the biggest stocks in the U.S. The Russell 2000 represents 10 percent of the Russell 3000’s market capitalization

Barclays Capital U.S. Aggregate Bond Index Formerly the Lehman Brothers Aggregate, this is a composite index that combines several bond indexes. It is a popular benchmark used to track the performance of U.S.-based investment grade bonds.

MSCI EAFE Index When investors want to see how international funds are performing vs. a benchmark, they often look at the MSCI EAFE Index. This index measures stocks of large and medium-sized companies in 21 international developed markets, excluding the U.S. and Canada. EAFE is an acronym for Europe, Australasia and Far East.