Benchmark in mutual funds – is it important for your investment decissions?
If you are about to buy a rice bag, there is no need to test the entire bag, right? If you can test a small sample of rice with your hand, that is more than enough to know the quality of the rice that you are buying. Similarly, while investing in mutual funds, if you compare any group of schemes with its relevant benchmark, that is enough for you to take your investment decision.
What is a benchmark in a mutual fund?
In the realm of investment, the selection of the right instruments can significantly influence the outcome of an individual’s financial strategy.
In addition, among these instruments, mutual funds have emerged as popular choices for investors seeking diversification and professional management.
And a critical component of evaluating mutual funds is understanding their benchmarks, which serve as reference points to assess fund performance relative to a specific market segment.
Moreover, this essay explores the importance of mutual fund benchmarks in shaping investment decisions and highlights how they can guide investors toward more informed choices.
What is an index?…
Before understanding about the mark for mutual funds, you should understand about index.
In addition, many of you may have heard about the National Stock Exchange, right?
Moreover, NSE is a stock exchange, which enables us to buy and sell the stocks in the secondary market.
And there are thousands of stocks listed on the Indian stock exchanges (NSE).
In addition, it will be very difficult for a layman to select quality stocks out of those thousands of stocks.
Again, it will be difficult for us to know the risks of buying those stocks.
So, in order to help investors, NSE created some ready-made indices like nifty 50 and small 250, nifty 500, etc.
Further, based on these indices, exchange-traded funds and passive index funds have been launched by mutual funds.
Moreover, apart from these index funds and ETFs, there is one more set of funds called actively managed mutual funds that also exist in mutual funds.
And the expense ratio in active funds is higher than that of index funds.
In addition, all active mutual funds will have a benchmark, which is nothing but an index designed by the stock exchange.
and the mutual fund company must disclose the scheme’s performance compared to the scheme’s benchmark in their fact sheets.
For example, all the mutual funds having an investment objective to generate returns by investing in large-cap stocks (top 100 stocks based on valuation of stocks) use the Nifty 50 as a benchmark.
Types of Benchmarks in India?…
Broad Market Index…
It is a most common benchmark, which comprises a broad range of stocks from various sectors and regions.
Example: Nifty 50 and BSE sensex.
Style Specific Index…
This bench mark tracks funds with similar styles, like value investing, growth investing, etc.
In addition, sector specific indices also exists which indicate the sector specific returns like phara sector I.T sector etc.
Which fund to invest in based on benchmark?…
For example, in one year, nifty 50 has given a return of 10%.
In the same year, the mutual fund scheme that you are looking to invest in has generated a return of 8% roi only.
So, it is very clear that the scheme failed to beat its benchmark in the above case.
And you should look at other schemes that have beaten the benchmark returns.
Benefits of Benchmarks in Mutual Funds…
Evolution of Performance…
Investors mainly use benchmarks to evoluate the performance of the muutal fund scheme.
In addition, comparing the returns of benchmarks with mutual fund schemes helps to identify effective management of the fund manager managing the fund.
Transeperancy…
Benchmarks offer full transparency.
As a result of this, investors will be able to analyse how the fund manager is handling the mutual fund scheme with respect to its benchmark.
Standased Analyisis…
Benchmarks are the yardsticks to evolve the mutual funds.
And this allows standardised analysis and comparisons across different funds.
Moreover, it will encourage investors to make informed decisions.
Risk Management…
Benchmarks help investors understand the risk involved in the mutual fund scheme by providing a reference point.
LIKE volatility and other inherit risks.
Historical return comparison to measure fund performance…
Investors can evolve the historical performance of the fund using historical benchmark performance.
Which will help investors to understand the longer-term performance of the fund rather than the short-term movements in the fund.
Cost-effective investment…
There is no point of paying higher fees to the fund management company in active funds if it is not beating the benchmark returns.
So, the benchmarks help to find out the best cost-effective active fund to invest in.
Read about Debt Mutual Funds—All you need to know…
Also read about Nifty 50 CAGR—How to Calculate for the Next 10 Years?…
And read about the market up-and-down ratio…
Also read about overlapping of mutual funds—all you need to know…
And read about liquid funds—all you need to know…
Also read about overnight funds—All you need to know…
And read about Nifty 50 and Nifty 50 Tri – What is the difference?…
Also read about the top mutual funds for sip in 2025 – All you need to know…
And read about High returning mutual funds Out of large, mid, small and multicap funds- All you need to know…
