Benchmarks—Useful Tools to Gauge Investment Performance

When you receive an investment account statement, it shows the performance of the funds in which your assets are invested. You probably have noticed that your statement also shows the performance of each fund’s benchmark. This article discusses the importance of benchmarks and provides information about the benchmarks used by the General Board.

What Is a Benchmark?

A benchmark is a standard used to measure the performance of an investment. One common benchmark is the S&P 500 Index, which consists of 500 large U.S. companies. The goal of many investment funds is to select the stocks of companies that may perform better than the S&P 500. Comparing the results of an investment fund to its benchmark, such as the S&P 500, allows investors to gauge the success of their investments.

Why Are Benchmarks Important?

In order to understand the importance of benchmarks, it is necessary to grasp the concepts of actively managed funds and passively managed funds. Actively managed funds attempt to select investments that will perform better than their benchmark. In contrast, passively managed funds attempt to replicate the performance of their benchmark.

Benchmarks help investors evaluate how well an actively managed fund has performed compared with a passively managed fund, which is represented by the benchmark. Passively managed funds charge much lower fees than active funds because they do not make active decisions. Specifically, actively managed funds incur expenses related to research efforts and services that help select the stocks. Passively managed funds, however, avoid most of these expenses. These funds hold the same securities that are included in the benchmark as a way to closely replicate the benchmark’s performance.

Suppose an actively managed fund has earned an average 10% annual return over the last 10 years. Without more information, it may appear that the fund has performed well. However, if that fund’s benchmark earned an average 15% annual return in the same period, the actively managed fund’s performance does not justify its higher fees. The General Board uses both passive and active strategies in its investment funds.

Benchmarks also can provide information about potential future risks and returns. For example, the S&P 500’s historical performance can give investors an idea about the types of risks and returns they might expect from large U.S. stocks. However, it is very important to remember that benchmarks only provide information about potential risks and returns—they will never guarantee success.

How Does the General Board Select Its Benchmarks?

For each of its funds, the General Board first develops a strategy that it believes is the most prudent. Building broadly diversified strategies is a key element of the General Board’s funds. The General Board then evaluates several benchmarks and selects the one that best aligns with this strategy.

The General Board sometimes selects a benchmark that is not as widely known, but that more closely aligns with a fund’s strategy. For example, the Dow Jones Industrial Average is probably the best-known benchmark for the U.S. stock market. However, the General Board does not use this benchmark for its Domestic Stock Fund because the Dow Jones comprises only 30 large U.S. companies. Since the Domestic Stock Fund invests in a broad universe of large and small U.S. companies, the General Board uses the Russell 3000 Index instead. This index includes a more broadly diversified set of large and small U.S. companies, making it a more appropriate Domestic Stock Fund benchmark.

The General Board diligently strives to select the best possible investment benchmark for each of its funds to assess performance and provide an indication of potential risks and returns. More information about the General Board’s funds is available on the Investment Funds page.