A benchmark is a point of reference against which the performance of an investment or fund manager can be measured. In finance, benchmarks are usually indexes made up of a basket of stocks that represent a particular market or sector. The most common equity benchmarks are the S&P 500 and the Dow Jones Industrial Average in the United States, while in Europe the FTSE 100 is commonly used.
There are also benchmarks for other asset classes, such as bonds, commodities, and alternative investments. For example, the Bloomberg Commodity Index is a widely followed benchmark for commodity prices. The performance of a fund or investment manager is typically measured by how much their returns outperform (or underperform) the relevant benchmark index.
When choosing a benchmark, it is important to make sure that it is appropriate for the investment in question. For example, if you are investing in a small-cap stock fund, then using the S&P 500 as your benchmark may not be ideal, as the S&P 500 is made up of large-cap stocks. In this case, a better benchmark would be an index of small-cap stocks.
The choice of benchmark can also impact the returns of an investment or fund. For instance, if a fund manager knows that their performance will be measured against the S&P 500, they may be more likely to take on more risk in order to try and outperform the index. This is why it is important to choose a benchmark that is aligned with your investment goals and objectives.