Evaluating Your Performance
Most investors do not evaluate the performance of their investment portfolio. This means most investors are unaware of whether their portfolio is trailing a passive benchmark or whether they are getting value for the fees they are paying their investment advisors.
To help you gain more clarity, this post will offer some simple methods to evaluate the performance of your investment portfolio.
Why Evaluate Performance?
Early into my investing career, I was having a beer with one of my best friends. We were chatting about our investments, and I mentioned how happy I was with my returns. My friend asked: “how do you know your returns are good”?
Up till then, I had just assumed that since my account value was rising, that I was doing ok. But, my friend pointed out why I should judge my returns against a relevant benchmark. Afterall, a rising tide lifts all boats.
A rising account value didn’t mean my investments were doing good. Afterall, the passive index benchmarks were rising too. I should be wondering whether my own returns are above or below the average.
And, if my own returns trailed the average, I should be using index funds instead of trying to find good investments on my own (saving both time & money).
From that point onwards, I have been dutifully tracking the results of my investment portfolio. The results have been illuminating.
It turns out my investing returns have been near my benchmark index over the past few decades. But it also turns out that the index rate of return has been pretty good. And as a by-product of tracking my own performance, I have gained greater clarity and financial peace of mind.
Clarify the Data
Below are a few key elements that should be part of your investment performance measurement process:
- Track your progress
- Benchmark your returns
- Evaluate returns and risks
- Report your results
Tracking
Institutional investors can use performance reporting software build for their purpose. But since individual investors can’t afford such solutions, most of us can simply rely on Excel. Excel works because its cheap, easy to use, and has a lot of built in calculation functions.
Using Excel, you should be tracking three main data points each month: 1) date, 2) account value, and 3) deposits/withdrawals.
With this data, you can use Excel’s built in functions to calculate your rate of return.
It is critical that your measurement process consider deposits and withdrawals. Deposits do not count as gains, and withdrawals do not count as losses. Your performance measurement process should strip out deposits and withdrawals to find the actual rates of return.
Benchmarking
After you have the facts in an Excel sheet, choose an index fund to benchmark your returns with.
Its important that you choose a relevant benchmark that is investible. This means, your benchmark is a possible investment you can practically make, not just a hypothetical number. Because to be fair, you want to measure alternative rates of return you could practically achieve.
Keep track of the returns of your benchmark(s) index funds in the same way you’re logging the results of your various investment accounts.
Returns & Risk
When evaluating your performance, returns are only part of the story. You should also evaluate the risks your portfolio is taking. This means measuring returns and volatility.
You can evaluate returns using an IRR method, and a Dietz method.
You can evaluate risk using a standard deviation method or tracking Sharpe ratios.
Reporting
Once you have all the data, you need to evaluate your returns. Visualize your results to make them easier to understand.
Most investors find it helpful to see and discuss their returns rather than rely on bare facts. So, it can be helpful to create charts and graphs for this purpose.
Evaluate your performance in standardized way each period so that its easy to compare progress over time. For example, save a PDF copy of your performance report of each evaluation period for later reference and share it with your family or colleagues to provide additional accountability.
Warning
Here is a warning for investors who rely on professional investment advice.
What value is your investment advisor providing you?
This is an important question for investors with advisors to ask because investment management fees typically make up the overwhelming majority of the fee’s investors pay each year.
If your investment advisor provides you with value by their investment performance alone, then you need to evaluate it. Unsurprisingly, most investment advisors don’t provide their clients with useful performance measurement reports. Why? Because most investment advisors fail to outperform their passive benchmark. Investment advisors don’t want to expose their failure.
Remember: a rising tide lifts all boats.
When prices are rising generally, your account should be rising too. But, this doesn’t mean your advisor is providing you with value for the fees you’re paying. The important part to evaluate is whether your account is outperforming a passive index benchmark.
So, you should demand reports showing the result from your advisor.
Hopefully, your investment advisor provides you with value in other ways outside of investment performance. If so, put these down on “paper” too and then evaluate the fees you’re paying compared to the services you’re receiving.
What to do next?
If the methods mentioned in this post sound like a lot of extra work that you don’t have the time (or desire) for, then this is where our family office can help.
Most investors do not evaluate the performance of their investments. They just assume their performance has either been good or bad. Our family office will provide you with real answers instead.
By evaluating the performance of your investment portfolio, you will achieve better results and greater peace of mind. Independent evaluation will also enable you to make your investment managers accountable.
If your portfolio is greater than $10 million, our family office will provide a complimentary evaluation of your investment results using the methods discussed in this post. Please get in touch with us for further details.