If you’re new to the world of investing and still get confused by the terminology, then this article is just for you, as today we will be talking about what benchmarks are and why they’re so often discussed in the financial world.

What is a Benchmark? 

A benchmark is a particular standard against which we measure the performance of a mutual, security fund, or investment manager. Usually, market-segment stock and bond indexes are used for that purpose.

Why are Benchmarks Important? 

We use benchmarks to measure performance. When it comes to investing, a market index can be used as a benchmark against which to measure the performance of a particular portfolio.

There are benchmarks created for all different types of asset classes. For example, the Dow Jones and the S&P 500 are the most popular large-cap stock benchmarks in the equity market. In fixed income, on the other hand, top benchmarks include the likes of Barclays Capital U.S Aggregate Bond Index and the Barclays Capital U.S Treasury Bond Index. 

Choosing the proper benchmark for your investments is vital because picking the wrong one can lead to benchmark error. To prevent that from happening, it’s vital to use the best fitting benchmark or market when assembling a market portfolio under the CAPM (Capital Asset Pricing Model). For example, if you want to create a portfolio of tech-heavy stocks, you have to use the NASDAQ as your benchmark instead of the Dow Jones. Similarly, if you’re going to have a portfolio of American stocks, you would use the CAPM and not the Nikkei (a Japanese index) as your benchmark.

Why is it important to know what your Financial Advisor uses as a benchmark?

If you don’t know what benchmark or benchmarks your financial advisor uses, you will find it really hard to evaluate how good of a job they’re doing. That’s because you won’t know what to compare your portfolio’s returns to. 

On the other hand, when you have a benchmark portfolio, you will be able to know the overall performance of your investments because you can compare them to a specific standard that indexes such as the S&P 500 or The Wilshire 5000 represent.

Is it more important to look at the dollars made or the percentage return?

People tend to have one main goal when it comes to investing: making money. And so, when you start to invest your hard-earned dollars, you will want to have a way of knowing whether that’s making you richer or poorer. 

Usually, in order for you to do that, you either have to look at percentage returns or dollar returns. So what do those terms mean? A dollar return is easy to measure and understand as it represents the exact currency return you made from an investment. So if you invested $50 into stock and a year later sold it for $65, you would get a return of $15. On the other hand, percentage investments show you how much the value of the investment has changed in proportion to its initial size. To put it in simple terms, the dollar return shows you the actual net proceeds or losses, while the percentage return shows how much your stock value has changed. 

Both of these metrics are useful to investors and are essential to look at and understand. However, if you’re a beginner, it’s easier to understand the dollar return, as it’s a more simple way of showing you whether you’re earning or losing money from your portfolio.