Q: I'm new to mutual fund investing. In the fund literature I've been reviewing, each fund lists its historic performance, as well as the performance of something called a "benchmark." What does this mean?

When it comes to mutual fund investing, a benchmark generally refers to a stock market index with a similar investment focus. For example, a mutual fund that owns a diverse group of large-cap stocks may use the S&P 500 index as its benchmark, while a fund that invests in tech stocks might use the S&P North American Technology Sector index.

The purpose of comparing a mutual fund's performance with a benchmark is to see how that fund is performing relative to similar investments. For example, how did an actively managed mutual fund that invests in banks perform versus a passive stock index that invests in banks as well?

Consider this example. Let's say that the S&P 500 gains 10% this year, and that a financial-sector mutual fund you own only gains 3%. At first glance, it may sound like your fund's performance was pretty lousy.

However, if the S&P Financials Select Sector index, a popular sector benchmark, declined by 5% for the year, your mutual fund would have handily outperformed its benchmark. In other words, when compared to other financial sector investment vehicles, your investment's performance was well above average.

In short, benchmarks help investors (and fund managers) make apples-to-apples comparisons when it comes to their current and prospective investments.

Although it's important to emphasize that a fund's past performance doesn't guarantee its future results, searching for mutual funds with solid track records of beating their respective benchmark indexes can be a smart strategy, and can also help you determine if you'd be better off simply using passive index-tracking funds instead.

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