Definition of Benchmark
A benchmark is a standard to measure the performance of a security, investment or mutual fund.
Generally, market segment stock, the broad market and bond indexes are used for this purpose. Such measures may be based on published indexes or may be customized in accordance with the strategy of the investment.
Whenever investors or companies evaluate the performance of any investment, it is necessary to make comparison of it against an appropriate benchmark.
In the field of finance, there are different types of indexes which are used by financial analysts to gauge the performance of any investment, including the Dow Jones Industrial Average, the Russell 2000 Index, and S&P 500. These benchmarks are considered to be the benchmarks for the wider economy.
Using the benchmark approach, investors can communicate their wishes easily to the portfolio manager. Portfolio managers can make investment decisions according to the requirement of the investor.
A good benchmark must reflect the true picture of the investment style and strategy. For instance, the Russell 2000 may be a suitable benchmark for portfolio investing in small caps, domestic stocks only, but it cannot be appropriate for the investment in bonds.