Achieving an accurate measurement of your portfolio’s performance is an important, but sometimes challenging, part of any investing strategy. Being able to confidently measure the performance of your equities, fixed interest and savings vehicles can help you stay on track to meet your long-term financial goals and so should be an integral part of the process. Here are some factors to consider.
Firstly, one key is not to expect positive returns every time you carry out investment performance measurement. Over the course of any day, month, year or longer period, your portfolio value may be up or down—that’s the nature of investing. The goal of your investing strategy should be to reach your long-term goals, which may mean accepting short-term volatility along the way. Of course, this does not mean you should ignore portfolio performance measurement entirely, but it’s important to put that measurement in proper context.
There are a number of different factors you will need to consider for performance measurement—these will largely depend on your goals and how your portfolio is constructed.
Your financial adviser should help you identify the specific factors relevant to you and your objectives. Identifying the wrong factors could easily lead you to the wrong conclusions. Regardless of your investing strategy and asset class makeup, you should consider the following for effective investment performance measurement:
Calculating returns relative to a benchmark—A benchmark can be a helpful tool to construct a portfolio and can be used to evaluate the performance of your portfolio. Benchmarks should mirror the assets that are appropriate for your goals. For instance, if your goals require an all-equity allocation, you might use a broad, global equity index—such as the MSCI World—as your benchmark. A benchmark should be the basis for building your portfolio. While you can build a portfolio that weights parts of the market you think will do best more heavily and weights parts of the market you think will perform worse less heavily, your benchmark should act as an anchor. The more significantly your portfolio differs from your benchmark, the greater risk you may be taking.
Once you’ve built your portfolio, your benchmark then serves as a helpful way to measure performance over time. You can evaluate whether your investment strategy has been working by comparing your performance, net of fees, with that of your benchmark.
Capital appreciation—This stands alongside dividend and interest payments as one of the major sources of total return. Capital appreciation is any rise in the value of an asset above its original cost.
Income—Dividends or interest payments paid from a financial asset, such as an equity or fixed interest security. Income is typically reported as an annual figure.
Fees and costs—Depending on your portfolio and investment manager, there can be many costs to consider. One is the cost of buying and selling securities, for which you typically pay a brokerage commission. Other costs can include management fees paid for funds in which you’re invested, fees paid to the adviser who helps you select securities, and many more. If you’re unsure what fees you’re paying, ask your investment adviser. If you don’t use an adviser, consult the institution where your assets are held. Fees, particularly those paid over time, can take away from a portfolio’s performance, so it is important to consider the impact.
Portfolio cash flows—This factor is important, but can be easy to overlook and difficult to account for. Withdrawing money from your portfolio should not detract from your performance measurement. Obviously, it wouldn’t be fair to your portfolio strategy to equate a 10% withdrawal with a 10% reduction in performance. There are many ways to account for withdrawals in your calculation, but it is important to weight each distribution by the amount of time the money was invested. Again, this can be challenging for an individual investor, so you may benefit from consulting your adviser about how to appropriately factor cash flows into your investment performance measurement.
Total rate of return—Your total rate of return should account for all the factors. It should include the total return of your portfolio—capital appreciation and income—and include the effects of fees and portfolio distributions. Once your total return is calculated, you can compare it to the performance of your benchmark.
Tax efficiency of your portfolio—Whilst it may not be appropriate to factor taxes into your performance measurement, taxes should certainly be considered. Taxes on dividends, capital appreciation and more should be considered when calculating an after-tax portfolio value. You should consider specific tax rules and how any changes will affect your wealth in the long term.
In most cases, comparing your portfolio return relative to that of a similarly constructed index is the easiest way to gauge whether you’re on the right track. A clearly established reference point means you can more meaningfully measure returns.
Successful investing generally requires establishing long-term goals, choosing the optimal benchmark to achieve those goals, and then sticking with the strategy. Inevitably, you will need to stay disciplined when faced with volatility and uncertainty, whether this is economic, political, or confined to performance of specific asset classes.
For investors with long-term goals, investment performance measurement tends to be most meaningful over longer periods. Such investors may have more exposure to equities, which tend to have greater volatility in short time frames than other asset classes. Whilst it is natural to want to know your portfolio performance over shorter time frames, making portfolio decisions based on short-term portfolio moves could ultimately prove to be a mistake.
Responding to volatility with hasty reactions could prove detrimental to your portfolio’s long-term returns. For example, negative volatility in a particular sector may provoke you to sell at a loss. If the dip ultimately proves to be a temporary correction, you could miss a subsequent bounce-back.
Conversely, when a particular sector has experienced strong performance, it can be tempting to concentrate investments in this one area without full consideration and calculation of the risks. But, this tactic often serves only to increase the risk of loss—for an instructive lesson in this regard, remember the technology boom in the late 1990s.
A financial adviser can guide you through difficult times and help you avoid unnecessary trading commissions and opportunity costs. These can detract from long-term results, so a good adviser will actively help you stay on track for long-term success during times of market turbulence.
Whilst performance measurement is crucial to your existing portfolio, basing your decisions on past performance, of markets and advisers alike, can be dangerous.
Past performance does not guarantee future results and no one can promise to match past returns or outperform a benchmark without risk. Hiring an investment firm based solely on past performance can be risky.
Fisher Investments Australia® offers investment management services provided by Fisher Investments, its parent company in the United States founded in 1979 by Ken Fisher. Combined, Fisher Investments, Fisher Investments Australia® and their affiliates help clients all over the world to create appropriate portfolios and measure performance over time.
If you have $750,000 or more in investable assets, contact us to speak with our representatives and start the conversation today. Our qualified professionals can provide you with a complimentary portfolio analysis, including a breakdown of the fees you’re currently paying (you may not realise how much you’re actually paying!). If you decide to become a client, Fisher Investments Australia® has a team who will help make the transition as smooth and seamless as possible. You’ll also receive a dedicated Investment Counsellor who will help guide you and provide information and support.