Importance of Benchmarking

As an investment strategy, one of the things that individual investors need to do is compare their portfolio to an actual index. This type of benchmarking is crucial if one is to determine just how successful the portfolio in question is performing against the index or a group of indices. And while most professional and semi professional investors certainly use a benchmarking process to weigh their performance, most of us do not have the know how or technical ability to do so quickly. If that describes you, then here are four basic indices that you will want to know about when building your personal benchmark:

- S&P 500. As your most popular index, the S&P 500 will measure the broadest stocks that are traded on US exchanges. These will include dividend paying stocks, large cap companies. As the Standard and Poor's website puts it, their widely watched index includes "500 leading companies in leading industries." This makes for a good benchmark for your core holdings.

- MSCI EAFE. The MSCI EAFE index measures the performance of companies within 22 developed-world countries outside of Canada and US. This would be relevant for the non-US holdings portion of your portfolio, and MSCI has been around for over 40 years providing index information.

- Russell 2000. The Russell 2000 is a great index if you carry small capitalization companies in your portfolio. This would typically be a specialty asset class within your portfolio, but many investors are now looking at Small Caps as a way to properly balance their portfolio while still getting the domestic exposure they want or need.

- Merrill Lynch Bond Index. This index by one of the leading investment banking companies, provides a way to measure how your bond portfolio is doing.

As with all of the index creators and monitoring companies outlined above, you can find indices for virtually every asset class using any of the systems outlined here. For example, Standard and Poor's can provide a fixed income index as well as other specialty asset class indices that are relevant to your portfolio. The point is to get as much diversification as possible, so you could use Standard and Poor's for your core equities, MSCI for your non-domestic equities, and Merrill Lynch for your Government bonds, etc..

Ultimately, using a benchmark that corresponds to your individual portfolio will provide you with a way to measure just how successful you are when it comes to your investments. This is important as it will help you determine whether changes need to be made and in which specific categories.

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Chris has more than 17 years of financial services experience. He currently writes for the Mutual Fund Site and has been exploring the disadvantages of bond funds. Check out his realistic approach at the Mutual Fund Site.