What is a Benchmark?
The meaning of benchmark refers to a standard or point of reference used to measure the performance of a financial asset, portfolio, or investment strategy. In finance, benchmarks serve as a way to evaluate and compare the relative performance of different investments. They provide a basis for measuring performance and help investors to assess their returns relative to a specific benchmark.
The most common benchmark in finance is a stock market index, such as the S&P 500, which is a measurement of the performance of 500 large publicly traded companies in the United States. Other commonly used benchmarks include bond market indices, such as the Barclays Aggregate Bond Index, which measures the performance of the U.S. investment-grade bond market, and commodity indices, such as the Thomson Reuters CRB Index, which tracks the performance of 17 commodities.
Benchmarks can also be custom-designed to meet the specific needs of an investor or portfolio. For example, a portfolio manager may use a benchmark that is specifically designed to reflect the characteristics of their portfolio, such as its sector exposure, risk profile, or investment style.
Simplified Example
A benchmark in finance can be compared to a yardstick or a measuring tape. Just as a yardstick or measuring tape is used to measure the length or size of an object, a benchmark is used to measure the performance of investments or portfolios. Just as a yardstick or measuring tape might be used to compare the size of different objects, a benchmark might be used to compare the performance of different investments or portfolios. Just as a yardstick or measuring tape provides a standard for measurement, a benchmark provides a standard for evaluating investment performance. In short, a benchmark in finance is like a yardstick or measuring tape, providing a standard for evaluating the performance of investments or portfolios.
History of the Term Benchmark
The term "benchmark" in finance traces its origins back to the mid-18th century, primarily associated with the practice of surveying land to create fixed points of reference. However, the term's application to financial contexts evolved during the late 20th century. In the early 1970s, it gained prevalence with the inception of stock market indices, notably the Dow Jones Industrial Average (DJIA) and the Standard & Poor's 500 (S&P 500). These indices became benchmarks, providing a comparative measure for evaluating the performance of investment portfolios and funds. Over time, benchmarks diversified beyond stock indices, extending to bond indices, interest rates, and other financial metrics. They serve as pivotal tools for investors, asset managers, and analysts, offering a standard against which financial performance and investment returns are evaluated.
Examples
The pan-European Stoxx 600 index provisionally closed up by 0.7%, having recouped early losses of more than 1.3%. Oil and gas stocks added 3.1% to lead gains while food and beverages fell 1.2%.
The Dow Jones index included the 12 largest companies in the United States, and today the Dow Jones Index (DJI) contains the 30 largest and most influential companies in the United States.
The FAO Food Price Index averaged 132.4 points in December 2022, down 2.6 points (1.9 percent) from November, marking the ninth consecutive monthly decline and standing 1.3 points (1.0 percent) below its value a year ago.
Related terms
Benchmark Index: A benchmark index is a financial market index that serves as a benchmark or reference point for measuring the performance of a particular asset class or market segment.
Consumer Price Index (CPI): The Consumer Price Index, or CPI, is a way to measure how much prices have gone up or down for things that people usually buy, like food, clothes, and gas.