Ask the average mutual fund investor how well a portfolio is performing and you’re likely to get a variation of three basic answers: “Pretty well.” “Lousy.” “Just treading water.”
Ask a professional money manager and you’ll hear something like: “We outperformed (or trailed) the S&P by 200 basis points.”
In other words, while many individual investors rely on gut feelings to assess performance, the professionals use a benchmark. Without one, you just don’t know how you’re doing, and you’re more likely to make ill-informed decisions about buying, selling or holding firm.
So how do you pick a benchmark, and how do you track it?
The most commonly used benchmark is the Standard & Poor’s 500, which tracks the largest 500 U.S. stocks, providing a gauge of the overall stock market’s performance.
The S&P 500 is a good standard for comparison because anyone can easily match its returns by investing in an S&P 500 index fund or exchange-traded fund, offered by most fund companies and brokerages. The mutual fund company T. Rowe Price (Stock Quote: TROW), for example, offers the Equity Index 500 Fund (Stock Quote: PREIX) and there is a popular exchange-traded fund called the SPDR S&P 500 (Stock Quote: SPY).
If you own a mutual fund containing stocks of large U.S. companies, you know you’re doing relatively well if you do better than one of these index investments. If you’re trailing, you’d be better off with the indexer or something else that beats the benchmark.
But the S&P 500 is not the right benchmark to use if you have a fund with small-company stocks. In that case you could use the Standard & Poor’s 600 index, which tracks small stocks. For mid-sized companies you could use the S&P 400 index.