Benchmarks

Lesson

Benchmarks are standard measures used to evaluate the performance of a specific investment or a group of investments. They help investors and financial professionals make informed decisions about the suitability of an investment vehicle.

Practice Question #1

Which of the following is a widely recognized benchmark for large-cap U.S. stocks?

A) Russell 2000 Index

B) S&P 500 Index

C) MSCI EAFE Index

D) Barclays U.S. Aggregate Bond Index

Select an option above to see an explanation here.

A) The Russell 2000 Index is a benchmark for small-cap U.S. stocks. B) The S&P 500 Index is a widely recognized benchmark for large-cap U.S. stocks. C) The MSCI EAFE Index is a benchmark for international stocks. D) The Barclays U.S. Aggregate Bond Index is a benchmark for U.S. bonds.

Terms

Benchmark:: A standard measure used to evaluate the performance of an investment or a group of investments.
Relative Performance:: The performance of an investment compared to a benchmark or another investment.
Tracking Error:: The difference between the performance of an investment and its benchmark.

Practice Question #2

What is the primary goal of passive management?

A) To outperform a benchmark index

B) To replicate the performance of a benchmark index

C) To minimize tracking error

D) To maximize risk-adjusted performance

Select an option above to see an explanation here.

A) The primary goal of active management is to outperform a benchmark index. B) The primary goal of passive management is to replicate the performance of a benchmark index. C) Minimizing tracking error is a secondary goal of passive management. D) Maximizing risk-adjusted performance is a goal of both active and passive management.

Do Not Confuse With

Absolute Performance:: The performance of an investment without comparing it to a benchmark or another investment.

Practice Question #3

Which of the following measures the sensitivity of an investment's returns to the overall market or a benchmark?

A) Alpha

B) Beta

C) Tracking Error

D) Sharpe Ratio

Select an option above to see an explanation here.

A) Alpha measures the excess return of an investment relative to its benchmark. B) Beta measures the sensitivity of an investment's returns to the overall market or a benchmark. C) Tracking error measures the difference between the performance of an investment and its benchmark. D) The Sharpe Ratio measures risk-adjusted performance.

Historical Example

In the late 1990s, the NASDAQ Composite Index was a popular benchmark for technology stocks. During this time, many technology-focused mutual and exchange-traded funds (ETFs) sought to outperform the NASDAQ Composite Index. However, when the technology bubble burst in 2000, many of these funds experienced significant losses, highlighting the importance of understanding the risks associated with benchmark comparisons.