Pay attention to financial news and you'll quickly realize that investing pros tend to measure our economy in terms of indexes: The Dow, for example, may be up 2% on a given day, or the S&P 500 may have fallen 30 points.
These indexes, which serve as important benchmarks for Wall Street, track the performance of hundreds, or even thousands, of companies. Watching them helps professional investors understand how the overall stock market, or specific sectors of it, are performing. Traders sometimes use the big ones, like the S&P 500 or the Dow Jones Industrial Average, as shorthand for the state of the entire economy.
There are also benchmarks that set the standard for investments ranging from small cap to bond funds. Even actively managed funds — which employ professional stock-pickers to select investments — use a comparison benchmark index to determine if their management is providing better returns than the overall market.
All this can be confusing for individual investors, as many people try to measure the performance of their portfolios against that of a broad index like the S&P 500 or the Dow. Here's a closer look at how to think about what these benchmarks do, and don't, mean in relation to your own investments.
Over the past century, the S&P 500 has seen average annual returns of just over 10%. But don't assume your portfolio is falling short if it doesn't match that average in a given year. Here's what to keep in mind to better understand how your portfolio is doing.
The bottom line: Benchmarks provide a good way of measuring the overall health of your investments' performance, so long as you understand that it's very hard to consistently meet, let alone beat, them.
Your portfolio doesn't need to, and probably won't, exactly match a benchmark's performance, and that's OK. A diversified portfolio will contain a mix of assets optimized for steady upward performance.
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