Just as a car salesperson uses the "blue book" to gauge the approximate price for a newly acquired vehicle, you can use market benchmarks to gauge the approximate performance of your mutual fund investments. Each market index tracks a representative sampling of stocks, bonds, or other securities that may be similar to the holdings in your investment portfolio.
Often tracked in financial websites and newspapers, benchmarks can be especially helpful to individual investors by offering a framework whereby they can evaluate the risk and return history of their own investments. The important consideration to keep in mind is that, when using benchmarks to compare to your investments, you should always compare apples to apples. In order to accurately do this, it helps to be familiar with a variety of benchmarks and the sectors and asset classes they track.
What Are Benchmarks and How Are They Used?
The dictionary defines a benchmark as "a point of reference for measurement." In investing, benchmarks are measurements used by investors, portfolio managers, and market watchers to track how a particular asset class or sector performs and to compare relevant investments to that measurement.
A Variety of Measures
Some of the more popular and widely used indexes include:
• IBC's Money Fund Report Averages®: These benchmarks track the averages of taxable and tax-free money market fund yields on a 7- and 30-day basis.1
• Barclays Aggregate Bond Index: A combination of several bond indexes, Barclays indexes are among the most widely used benchmarks of bond market total returns.
• 10-Year U.S. Treasury Bond: The yield on this long-term U.S. government bond is often looked to as the standard bond yield for long-term bond investments.
• Standard & Poor's Composite Index of 500 Stocks (S&P 500): A broad-based, unmanaged index of the average performance of 500 widely held industrial, transportation, financial, and utility stocks. Many people believe that this, one of the most often-cited indexes, includes the 500 largest stocks on the New York Stock Exchange. Not true: In fact, it includes the stocks of companies that are or have been leaders in their respective industries and that are listed in the New York Stock Exchange and the NASDAQ Market System. The industry weightings in the S&P 500 are selected to reflect components of the Gross Domestic Product (GDP).
• Dow Jones Industrial Average: Following the returns of 30 well-established American companies, the Dow is among the most renowned of the stock market indexes. However, the S&P 500 can be considered a broader indicator of the stock market. The Dow has usurped much of the focus of the newspapers' investment pages because of its unprecedented string of double-digit gains in the late 1990s.
• The Nasdaq Composite Index: This index was created in 1971 and measures all domestic and non-U.S.-based common stocks listed on the NASDAQ market. It contains many new-economy companies and is widely acknowledged as a benchmark for technology stocks.
• Morgan Stanley Capital International's Europe, Australasia, Far East (EAFE) Index: The most prominent of the indexes that track international stock markets, the EAFE is composed of companies considered representative of 20 European and Pacific Basin countries.
In addition to the above, there are many others including the Value Line Composite Index (stocks); the Russell 2000 Index (small-cap stocks); the Citi 3-Month T-bill (money markets); the Dow Jones World Stock Market Index (major international markets, including U.S.); and the Barclays Global Aggregate Bond Index (global bond index).
Many benchmarks, including those listed above, are reported regularly on major financial websites and in the business section of local newspapers; national publications such as The Wall Street Journal and Investor's Business Daily; and, internationally, in The Financial Times.
Using Benchmarks to Target Expected Return
Benchmarks can be used to assess what types of investments may be most suitable to an investor's goals and investment time frame. By looking at the past performance of a market index, you can gauge the relative return potential of a particular asset class, as well as its risk characteristics. Keep in mind, however, that past performance is not a guarantee of future results. Also, be careful to use the right benchmark. For example, you wouldn't want to invest in corporate bonds maturing in five years based on the benchmark performance of 10-year U.S. Treasury bonds. Your financial advisor can help you assess which benchmarks to use in evaluating the performance and risk of a given market.
In mutual fund investing, market indexes can be used as a benchmark to evaluate how a given fund has performed in relation to the overall market. Be careful to look at the fund's performance relative to the benchmark over time. Keep in mind that a fund that outperforms the benchmark some of the time and underperforms it in others can still be a good addition to your portfolio if it offers opportunities to diversify.
You may also want to look at indexes of specific types of mutual funds when assessing their performance.
Don't Rely Solely on the Blue Book
The short-term, stellar performance of a particular benchmark may spark your interest in a specific investment class or sector; but remember, you shouldn't buy the car based solely on the blue book price.
In other words, research the investment opportunity, your personal objectives, and risk tolerance before investing. And use the benchmark as just one more resource to keep tabs on your investment performance.
1. An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund.
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Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail firstname.lastname@example.org.
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