Benchmark serves an important role in investment. It is an accepted standard against which the performance of an investment is measured.

Simply, benchmarks are indexes formed to include multiple securities representing some aspect of the total market. This includes the performance of mutual funds, securities, and investment managers.

Identifying and setting a benchmark is an important tool of investment for individual investors.

In investing, the market index is used as a benchmark against which a portfolio performance can be evaluated.

Mumbai Interbank Offered Rate (MIBOR) and Mumbai Interbank Bid Rate (MIBID) are the interest rate benchmark in India for the Indian interbank market. Interest rate benchmarks help to set a standard or base to pay interest for deposits and loans.

Government bonds are almost always used as benchmark bonds such as “On-the-run U.S.Treasuries”

Investors often refer to the NIFTY 50, SENSEX, and NIFTY BANK as a performance measure for equity performances in India.

In fixed income, examples of top benchmarks include Barclays Capital U.S. Aggregate Bond Index, Barclays Capital U.S. Corporate High Yield Bond Index, and Barclays Capital U.S. Treasury Bond Index.

Benchmarks are tools that can be used in many ways for investors. All managed funds will have established benchmarks to monitor the performance of the particular fund.

Investors also choose to follow an array of benchmarks to ensure that their investments are favorably placed with the lowest risk and better possible returns.

Benchmark guides investors to identify opportunities for shifting portfolio investments to seek advantage of the market opportunities.

The use of benchmarks is highly effective to identify current and potential investments. It also ensures that an investor’s portfolio is optimally diversified and aligned with their goals.

Bond investors and fund managers use the benchmark as a yardstick to measure the bond performance and to understand the rate of return to demand in excess of the benchmark return. For a comparison to be appropriate the benchmark and the bond being measured against it should have comparable issue size, interest rate, and so on

Benchmarks exist in vast numbers and it becomes difficult to decide on which individual or combination of indexes to opt for. Here are self-studies to go through before deciding on the appropriate benchmark.

It is very important from the investors point of view to evaluate their goals and risk tolerance before approaching the benchmark index. Investors having less risk appetite will prefer to go for an index with a shorter duration whereas investors willing to take more risk can decide to go for an index that has generated a record of high long-term returns. High long-term returns may experience high volatility in short-term periods.

If a particular portfolio is targeted towards neutralizing the liabilities that change the interest rates, investors should select a benchmark index that has interest rate sensitivity rather than returns.

Another factor to consider is while an investor decides to invest the cash generated from daily operations which ultimately will be used to encounter short-term needs or obligations will need a portfolio that will be highly liquid and such requirement needs a benchmark index of short-term duration. Benchmarks with long durations and higher interest rates are of no use since the requirement is short-term.

Inflation plays a crucial role in deciding the returns on investment. Therefore an investor whose liabilities are interconnected with the levels of inflation opts for a benchmark of inflation-linked securities. There exist inflation-linked bonds whose interest rate and principal amount rise with inflation. Hence indexes that monitor the performance of specific investments that benefit from inflation like real estate can serve as benchmarks for portfolios invested in such asset classes.

A broad investment portfolio leads to an increase in returns and balances the volatility. If the benchmark index is too narrow, it becomes difficult to contribute to the portfolio's overall performance through active management. It is important to decide on how many different types of asset classes an investor is interested to invest in.

Although benchmarks cover almost all types of assets, investors should also consider the underlying risks in a benchmark as well as their risk tolerance level when evaluating an index.