Benchmarks and Indices

With a solid understanding of how returns are measured and tracked, you can now learn how investors compare their performance against the broader market. Benchmarks and indices provide the standard for measuring investment success.

Benchmarks vs. Indices

  • A benchmark is a standard against which investment performance is measured
  • An index is a statistical measure of the performance of a group of securities
  • Most benchmarks are indices, but the terms are not identical; a benchmark is chosen for comparison, while an index is a calculated measure

Major Market Indices

IndexWhat It TracksKey Facts
S&P 500500 large-cap U.S. stocksMarket-cap weighted; most widely used benchmark for U.S. equities
Dow Jones Industrial Average (DJIA)30 large-cap U.S. stocksPrice-weighted; oldest and most recognized stock index
NASDAQ CompositeAll stocks listed on the NASDAQ exchangeHeavily weighted toward technology stocks
Russell 20002,000 small-cap U.S. stocksPrimary benchmark for small-cap performance
Bloomberg Aggregate Bond IndexU.S. investment-grade bondsPrimary benchmark for fixed-income performance
Wilshire 5000Broad U.S. equity marketSometimes called the "total market index"

Exam Tip: Gotchas

  • The Russell 2000 tracks small-cap stocks, not the 2,000 largest companies. The name refers to the bottom 2,000 of the Russell 3000 index.
  • The Bloomberg Aggregate Bond Index (formerly Barclays Aggregate) is the go-to benchmark for bonds, not the DJIA or S&P 500.

Index Weighting Methods

How an index calculates its value determines which stocks have the most influence:

Weighting MethodHow It WorksExampleImpact
Price-weightedHigher-priced stocks have more influenceDJIAA $200 stock has 10x the influence of a $20 stock, regardless of company size
Market-cap weightedLarger companies (by total market value) have more influenceS&P 500, NASDAQ, Russell 2000Apple ($3T market cap) has far more influence than a $10B company
Equal-weightedAll components have the same influenceSome specialty indicesEvery stock counts equally regardless of price or size

Why it matters:

  • In a price-weighted index like the DJIA, a stock split reduces that stock's influence (lower price = less weight)
  • In a market-cap weighted index like the S&P 500, a stock split has no effect on weighting (market cap doesn't change)
  • Market-cap weighting is considered more representative of the actual market because it reflects total company value

Exam Tip: Gotchas

  • The DJIA is price-weighted, NOT market-cap weighted. This is a frequently tested distinction.
  • In a price-weighted index, a stock split reduces that stock's influence (lower price = less weight). In a market-cap weighted index, a stock split has no effect on weighting.

You Cannot Invest Directly in an Index

An important distinction to keep in mind:

  • An index is a mathematical calculation, not an investment product
  • Index funds and ETFs are investment products that track an index
  • These products aim to replicate the index's performance but have small differences due to fees, tracking error, and cash holdings
  • When someone says "I invest in the S&P 500," they mean they invest in a fund that tracks it

Think of it this way: An index is like a scoreboard. It tells you how the game is going, but you cannot play the scoreboard itself. To participate, you buy a fund (the team) that tries to match the scoreboard's results.

Exam Tip: Gotchas

  • You cannot invest directly in an index. Index funds and ETFs are separate investment products that track an index. The S&P 500 is market-cap weighted, meaning the largest companies dominate its performance.

Choosing the Right Benchmark

The benchmark should match the investment strategy:

Investment TypeAppropriate Benchmark
U.S. large-cap stocksS&P 500
U.S. small-cap stocksRussell 2000
U.S. investment-grade bondsBloomberg Aggregate Bond Index
Total U.S. stock marketWilshire 5000
Technology-heavy portfolioNASDAQ Composite