Course 202: Benchmarks
Indexes as Benchmarks
In this course
1 Introduction
2 Your Personal Benchmark
3 Indexes as Benchmarks
4 Peer Groups as Benchmarks
5 Our Approach

The most common type of performance benchmark is a market index a preselected group of securities. Such indexes are usually tracked by the media and the investing community as indicators of the health of national and international stock and bond markets. Of course, there's no consensus on the single best index to use for investing purposes. The Dow Jones Industrial Average (DJIA) may be the index that heads the stock market report on the evening news, but it's rarely used as a performance benchmark for stock mutual funds. Why? Because it's so narrow: It includes just 30 large-company stocks, so it isn't all that indicative of the health of the overall stock market.

The index you'll hear about most often in mutual fund circles is the Standard & Poor's 500 Index, which includes 500 major U.S. companies. The larger the company, the greater its position in the index. Because the stocks in the S&P 500 are chosen to cover a range of industry sectors, the index often paints a clearer picture of the overall market than the Dow Jones Industrial Average.

Yet despite its widespread appeal, the S&P 500's focus on large companies means it's not representative of the entire market and smaller stocks' performance in particular. It's therefore inappropriate to measure a fund that doesn't buy large companies, such as Fidelity Low-Priced Stock (FLPSX) or T. Rowe Price Small-Cap Stock (OTCFX), against this benchmark only. Nor should you compare a foreign-stock fund like Vanguard International Growth (VWIGX) with the S&P 500; that fund doesn't even own any U.S. stocks. And don't try to stack bond funds up against a stock-fund index like the S&P 500. This advice sounds like common sense, but investors make inappropriate comparisons all the time.

So what indexes can you use to make appropriate comparisons? The Russell 2000 Index, which tracks smaller U.S. companies, is a good tool to evaluate many small-company funds, while the MSCI EAFE ( Europe Australia Far East) Index, which follows international stocks, is a good measuring stick for foreign funds. The Barclays Aggregate Bond Index is a good gauge for most taxable-bond funds. There are dozens of other indexes that segment the market even more, focusing on inexpensive large-company stocks or pricey small-company stocks, regions of the world such as Europe or the Pacific Rim, or even particular areas of the bond market. We include appropriate indexes for each fund on Morningstar.com.

Next: Peer Groups as Benchmarks >>


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