| How to Use Benchmarks |
| If you've ever spent much time around a weight room at a gym, you might have heard the question, sometimes posed as a challenge, "How much do you bench?" |
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| The maximum weight that you can lift on the bench press is often regarded as the definitive statement of an individual's strength. Yet the question of what actually constitutes a "good" bench press is not so clear. In one sense it's a highly relative measure, dependent on body weight, age, previous conditioning, and so on. A 5'5" man who benches 175 may have a superior strength-to-body-weight ratio to a 6'2" man who benches 250. Yet there are also certain minimum, absolute standards: A 25-year-old male who cannot do even one repetition of 50 pounds would rightly be perceived as a weakling. Then, too, some might point out that the bench press can't tell you anything about your leg strength. |
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| The investing equivalent of "how much do you bench?" is "how did your fund do last year?" But if your fund returned 18%, how do you know whether that's good or bad? That's where benchmarks--the mutual-fund world's answer to the bench press--come in. Ostensibly objective standards of performance, benchmarks are in reality as adaptable as they are numerous. Yet they are crucial tools in the investment industry, not only for individual investors assessing performance but also for fund managers, who are often compensated partly on the basis of their performance relative to a benchmark. The proper reply to the question of how your fund performed last year, therefore, should be "Relative to what benchmark?" But before you can select an appropriate benchmark, you need to know the different sorts of benchmarks available and the benefits and drawbacks of each. |
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| Indexes as Benchmarks |
| The most common performance benchmark is the index--a preselected group of stocks perceived to have some significant correlation to the overall performance of the stock market or a segment of the market. But there's no consensus on the single best index to go by. The Dow Jones Industrial Average may be the index that heads the stock-market report on the evening news and the granddaddy of indexes, but nobody uses it as a performance benchmark. Why not? Because its composition of 30 giant blue chip stocks is barely indicative of the breadth of the stock market. The index perhaps most akin to the bench press--that is, a commonly accepted reference point--is the Standard & Poor's 500 index, a market-value-weighted index of 500 major companies. Probably the biggest advantage of the S&P 500 is that it's widely used and easily trackable through newspapers and other publications; also, because the stocks in the index are chosen to cover a range of industry sectors, the index offers greater breadth than the DJIA. Yet despite its widespread appeal, the S&P 500 carries a decided large-cap bias, and in recent years that has caused most smaller-cap vehicles to trail this index as larger stocks have led the market's charge. |
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