Definition:Financial Benchmark

A benchmark is a basis for comparison. A Financial Benchmark is thestandard against which the performance of a stock, bond, mutual fund, or any other financial instrument can be measured. That’s how you know if your mutual fund is outperforming the norm for a particular category of investment.

In the financial world, there are dozens of indices that analysts use to evaluate performance. The most common ones are:

Dow Jones Industrial Average (“Dow Jones”): A price-weighted index of thirty of the largest U.S. corporations.

S&P 500 (“Standard and Poor’s 500” or “S&P”): A market-capitalization-weighted stock index based on the market capitalizations of 500 leading companies, as determined by Standard and Poor’s, that are publicly traded in the U.S. stock markets.

Wilshire 5000: This index aims to track the returns of virtually all publicly traded, U.S.-based stocks that trade on the major exchanges. Like the S&P 500, the Wilshire 5000 is market-capitalization-weighted, so larger companies have more influence on the index’s movements.

NASDAQ Composite: a collection of 4,000 technology-oriented stocks. This index fund examines the technology sector of the economy as a whole, including tech stocks that are performing well or performing poorly.

The more individual stocks and sectors encompassed by an index, the “broader” it is relative to other indices. A broader index is less susceptible to sudden shocks to a particular stock or sector. That holds true for booms and busts alike, since the risks are spread across a wider range of investments. The broadest indices are best for viewing the market as a whole. That’s why they serve as benchmarks for comparison.

Of course, you shouldn’t stop at comparing past performance to a financial benchmark; there’s more to consider before assuming that a stock, mutual fund, or financial manager is a trustworthy investment. Keep this in mind as we turn to the big investment myths.