Benchmark
A benchmark is a standard, usually a market index, used to judge an investment's performance and risk. Comparing a fund with a suitable benchmark shows whether the manager added value or just followed the market.
Did your portfolio do well? That depends on what you compare it with. A 10% return is great if the market made 5%, and poor if it made 20%. Benchmarks provide that yardstick. This entry explains what makes a good benchmark, common examples and how investors use them.
- Category
- Risk Management
- Reading time
- 3 min
- Also called
- Benchmark index, Performance benchmark, Reference index
- Updated
Benchmarks in plain words
A benchmark is a measure investors use to analyse a portfolio's risk and return relative to other market segments.1
Common examples include the S&P 500, the Bloomberg (formerly Barclays) US Aggregate Bond Index, the Russell 2000 and REIT indexes.1
Index funds aim to match the return of a chosen index before fees, which makes them a natural benchmark alternative.2
How to choose and use a benchmark, step by step
Match the asset class
Stocks vs stocks, bonds vs bonds.
Match the style
Large or small, growth or value. See Growth vs Value Stocks.
Match the region
US, global, emerging. See MSCI Indices.
Use total return
Include dividends. See Total Return.
Compare over time
Several years, after costs.
Measure risk too
Volatility and drawdowns. See Sharpe Ratio.
Worked examples
Example 1 — Outperformance
Beat the benchmarkA large-cap fund returns 12%; the S&P 500 returns 10%.
| Excess return | +2 points |
Managers use benchmarks to compare portfolio performance and guide decisions.1 See Alpha.
Example 2 — Wrong benchmark
Lagged the right indexA small-cap fund returns 15%, compared with the S&P 500's 10%; the Russell 2000 returned 18%.
| Vs S&P 500 | +5 points |
| Vs Russell 2000 | −3 points |
Against a matching small-cap index, the fund actually lagged. See Russell Indexes.
Example 3 — Index fund comparison
Index fund winsAn active fund returns 7.6% after fees; an index fund on the same benchmark returns 7.9%.
| Difference | −0.3 points |
A cheap index fund tracking the benchmark is the practical alternative to beat. See Index Fund.
Common benchmarks
| Aspect | Covers | Typical use |
|---|---|---|
| S&P 500 | US large caps | US equity funds |
| Russell 2000 | US small caps | Small-cap funds |
| US Aggregate Bond | US investment-grade bonds | Bond funds |
| MSCI World | Developed markets | Global funds |
How benchmarks are used
Fund evaluation
Did the manager add value? See Alpha.
Fee justification
Active fees vs index returns. See Expense Ratio.
Risk measurement
Beta and tracking error. See Beta.
Personal goals
Benchmarks for your own plan.
Advantages and disadvantages
Advantages
- Objective yardstick.
- Reveals true skill vs market moves.
- Easy to track.
Disadvantages
- A poor match misleads.
- Can encourage index-hugging.
- Ignores personal goals and taxes.
Going deeper
Read as far as you need. Each level builds on the one before it.
Who sets it
Beginner
Investors assign benchmarks to managers, who compare performance and make decisions with expected results in mind.1
Passive alternative
Intermediate
Because an index fund aims for about the benchmark's return before fees, it shows what investors could have earned cheaply.2
Benchmark gaming
Advanced
Managers sometimes choose easy benchmarks or drift from their style to look better; check holdings against the stated index. See Window Dressing.
Common mistakes
Mismatched benchmarks
Compare like with like.
Price-only indexes
Use total-return versions.
Short periods
Judge over several years.
Ignoring risk
Higher return with much higher risk isn't better.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- A benchmark is the yardstick for performance.
- It should match asset class, style and region.
- Use total-return versions.
- Compare over long periods and after costs.
- A cheap index fund is the practical comparison.
Frequently asked questions
What is the most common benchmark?
Should I benchmark my own portfolio?
What is tracking error?
Further learning
- Stock Market Index
What most benchmarks are.
- Alpha
Return above the benchmark.
- Total Return
Measuring returns properly.
- Index Fund
Owning the benchmark.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- Corporate Finance Institute. Benchmark (opens in a new tab) Checked .
- Investor.gov (SEC). Index Fund (glossary) (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.