When you want to gauge performance, it's necessary to have something to compare against. Race cars have lap times, microprocessors use clock speeds and investments use benchmarks. For serious investors, benchmarking is essential. But how can you pick an appropriate benchmark for your portfolio? Here's a primer to help you get started.

What Is a Benchmark?

A benchmark is a tool for measuring the performance of an individual investment or portfolio of investments. According to Andrew Clark, Lipper's head of research for the Americas, a benchmark "is like a ruler." Clark says, "A ruler tells you how tall you are; a benchmark -- in terms of investing -- tells you how much money you've made."

Benchmarks are essentially a way to put your portfolio in perspective by comparing it against the market as a whole. For example, while a year-end 6% positive return might not be your idea of a great year, if your particular benchmark is up only 1% for the year, then you did pretty well.

Typically, indices like the S&P 500 ( SPX) and the Dow ( DJIA) are used as benchmarks because they're readily available to investors and provide a good idea of how the market is doing (see "Index Funds: Define Your Stock Market Index" ).

However, benchmarks aren't relegated to indices -- comparing an investment vehicle like a mutual fund against similar (or "peer") funds is also a valuable way to get a feel for performance.

Pick a Meaningful Benchmark

Just because the S&P and Dow are popular benchmarks doesn't mean that either is the right one for your portfolio, says Judith Ward, a CFP (certified financial planner) at T. Rowe Price. Ward explains: "Probably the most common benchmark that people use is the S&P 500 index and that is a good benchmark to gauge the stock market. But I think what investors need to understand is the kind of investments that they're in -- whether it's individual stocks or mutual funds -- they need to understand the investment and how it's similar or different from any particular benchmark."

So while the S&P might make a good benchmark for someone invested in large-cap stocks , it might not be a good choice for someone who's invested primarily in emerging markets . Even if your money is in U.S.-based companies or foreign companies (via ADRs ), company size is a big factor. For example, someone invested in small-caps might find the Russell 2000 Index ( RUT) to be a better benchmark than the S&P 500 or the Dow (see "Define Your Stock Market Index" ). As Clark puts it, "good benchmarks are fair representations of investments people either can, or allow themselves to purchase."

Blended Benchmarks

Even though investors have a lot of benchmark choices, don't be surprised if there isn't one that represents your portfolio perfectly. One way around this is with blended benchmarks.

"Blending" benchmarks is a way for investors to take different benchmarks and weigh them to create a unique hybrid.

As an example, let's say that your stock portfolio is made of 80% small-caps and 20% large-caps. To have an appropriate comparison point, consider a blended benchmark that's 80% Russell 2000 and 20% S&P 500.

T. Rowe Price's Ward agrees with this approach of "proportionally blending benchmarks to create a hybrid benchmark that's an accurate representation of your portfolio."

Benchmark Watch

So how often should you compare your portfolio against your chosen benchmark? Ultimately, the answer involves a two things: how actively you participate in your portfolio and the kinds of investments you're into.

Active investors (with more portfolio turnover ) will want to be more active in checking their benchmarks, for the simple fact that they're making decisions that can affect their performance more frequently than investors who rarely make changes to their portfolios.

Likewise, people involved in riskier investments (like small-cap stocks) will want to be more vigilant in comparing against their benchmarks than people who own less volatile ones.

Comparing your portfolio doesn't have to be a painful or difficult process, but checking the state of things whenever you make decisions is a pretty sound move. Clark says, "at a minimum," you should check your benchmark "when you're seeking to re-evaluate or rebalance your holdings."

Beating Your Benchmark

As important as benchmarks are for investors, it's important not to focus too closely on the benchmark itself. As an individual investor, benchmarks aren't the end-all and be-all; they're tools, nothing more.

"I always get concerned when people just try to beat benchmarks. For certain mutual funds, that may be what they're trying to do, but as a personal investor I think it may be kind of dangerous to get into that game," admonishes Ward.

So while a benchmark is a useful tool to determine how well your portfolio is "performing," focusing on beating a specific benchmark instead of meeting your unique investment goals can be a big mistake. That's why it's important to re-evaluate your investments and the benchmarks you measure them against on a regular basis.

Jonas Elmerraji is the founder and publisher of Growfolio.com, an online business magazine for young investors.