What is a benchmark?
A benchmark is a way to measure how well an investment portfolio has performed in comparison to the wider economy. For example if an investor bought an emerging cryptocurrency at the beginning of the year and their returns were 15% by the year’s end, they could look to the price of Bitcoin to see if this is a good return. As Bitcoin is the largest cryptocurrency by market cap, its price movements are correlated with how the rest of the crypto market performs.
If Bitcoin performed better it could indicate to an investor that their capital would have been better placed in Bitcoin to maximise their ROE (return on investment). If their chosen asset performed better than Bitcoin, the investor can have a gauge for how well their investment has outperformed the broader cryptocurrency market by looking at Bitcoin’s price over the same period.
For stock traders, benchmarks tend to be taken from indexes for large companies. Something like the Dow Jones or the FTSE 100 can give an indication for how well their chosen stock has performed compared to the wider stock market.
In addition, indexes specific to certain sectors can be used to measure how well an investment has performed in comparison to its sector. For example, someone who wants to see how well their investment in an energy company has performed could take a look at the S&P 500 Energy for comparison.
However, if the invested energy company specialised in green energy for instance, this comparison could lead to inaccurate comparisons as the S&P 500 Energy will collate all energy companies, so a more specific index could be better for more effective benchmarking.