What's Your Fund's Benchmark?

They say he who watches the clock becomes one of the hands.

The same can be said of watching market indices. At a time when earnings warnings are causing many stock prices to plummet, and a downward arrow is becoming an all-too-familiar prefix to major market indices, how closely should investors track their performance with regard to these market indicators?

Many planners say that it's important during turmoil not to become hung up on the markets' daily swings and to keep focused on long-term investing goals. But if you must obsess, make sure the indices you're looking at are comparable to the types of investments you hold, experts say.

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"It's really important that people pick the appropriate benchmark," says Morningstar's director of fund analysis Russ Kinnel. "You don't want to compare a small-cap value fund to the S&P 500, because they're entirely different universes."

As one of the most widely watched market indices for tracking large-cap U.S. stock performance, the S&P 500 tracks a representative sample of leading companies in leading industries. As of the end of September, its biggest components included General Electric(GE Quote) Cisco Systems(CSCO Quote) and Microsoft(MSFT Quote).

So, comparing a fund like the $180 million (KDSAX Quote)Kemper Small Cap Value fund, which invests in small, out-of-favor stocks like medical technology company Conmed (CNMD Quote) and Dollar Thrifty Automotive (DTG Quote) to the S&P 500 would not give an investor an accurate picture of the fund's relative performance.

Morningstar compares all funds to the S&P 500, regardless of their style, so that investors can get a sense of the fund's performance compared to the overall market, says Kinnel. But Morningstar also sizes up funds against others in their categories and compares the fund's risk and volatility measurements to both the S&P 500 and its "best fit" index -- in this case the Russell 2000 -- which tracks the performance of the 2,000 smallest companies in the Russell 3000 index.

But even if you are comparing your fund's performance to its appropriate index, planners say conclusions are still difficult to draw. That's because the weighting of companies in the index may be very different to what an investor actually has in his or her portfolio. And since many investors often have diversified holdings in stocks, bonds, cash or stakes in overseas companies, comparing returns to those of a U.S. equity index may be a moot point.

"It's really unfortunate when people manage to an index," says Glenn Frank, Adjunct Professor in the Masters of Financial Planning program at Bentley College and Partner of Tanager Financial in Waltham, Mass.

"The Dow Jones Industrial Average was set up decades ago. It's just 30 stocks. Someone can get much greater diversification another way."