A benchmark is a standard of measurement that is used to evaluate and compare the performance of a financial asset or investment portfolio. It is a reference that is used to evaluate the performance of an investment against some criteria or index, allowing investors to understand whether an investment is doing better, worse or as expected compared to a certain standard.
The main features of a benchmark include:
Comparability: The benchmark should be easily measurable and comparable to the performance of the asset or portfolio. It can be a stock market index, sector index, competitive mutual fund or other reference that provides a meaningful benchmark.
Representativeness: The benchmark should represent the characteristics of the investment being evaluated. For example, if an investor holds a portfolio of stocks, the benchmark could be a stock market equity index that reflects the overall performance of that market segment.
Stability: a good benchmark is stable and available for regular updating. This means that its composition does not change too often, allowing comparisons to remain consistent over time.
Objectivity: the benchmark should be objective and independent of investor decisions. It should not be manipulated to align performance with expectations.
Examples of popular benchmarks include stock market indexes such as the S&P 500, Dow Jones Industrial Average, or FTSE 100. Investors use benchmarks to evaluate the performance of their portfolios or investment strategies. If an investment’s performance outperforms the benchmark, it can be considered a successful investment. On the other hand, performance below the benchmark may suggest that the investment is underperforming the market and requires analysis and strategy adjustment. Benchmarks are also used to compare different mutual funds and evaluate portfolio management by professional fund managers.
