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. In this article we will discuss some tips and factors to consider.
Firstly, one key is to not search for or expect positive returns every time you carry out investment performance measurement. Over the course of any day, month, year or even longer in some cases, your portfolio value can 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 shorter-term volatility along the way. Of course, this does not mean you need to ignore portfolio performance measurement entirely, but that it needs to be put 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 you have constructed your portfolio.
Your financial adviser should help you identify the specific factors relevant to you and your objectives. Identify the wrong ones and you could easily be left with incorrect calculations and, ultimately, the wrong conclusions. Regardless of your investing strategy and asset class makeup, all of the following should be considered 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 be chosen to mirror the assets that are appropriate for your goals. For instance, if your goals require all equities, you may have 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 that of its original cost.
Income—Dividends or interest payments paid from a security such as an equity or fixed interest security, 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’ll 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 if they are 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. If you are distributing money from your portfolio, this 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 it was invested. Again, this can be challenging for any individual investor, so you may benefit from consulting your adviser about how to appropriately factor this 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—be net 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—While it may not be appropriate to factor taxes into your performance measurement, taxes should certainly be considered. Capital gains tax, dividend tax and more may need to be considered in order to calculate an after-tax portfolio value. You should consider the specific tax-relief 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. This is why your portfolio should be set up to track a benchmark for investment performance. 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 time frames. Such investors may have more exposure to equities, which tend to have greater volatility in short time frames than other asset classes. While 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.
By 'knee-jerk' responding to volatility, investors risk making the kinds of hasty decisions that, however right they feel in the moment, may prove detrimental to long-term returns. For example, negative volatility in a particular sector may provoke you to sell at a loss. If this 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 placing all one’s eggs in a single basket often serves only to increase the risk of loss—for an instructive lesson in this regard, look no further than the recent Bitcoin boom or, a little more distantly, Tech in the late 1990s.
A financial adviser should guide you through difficult times and help you avoid excessive trading commissions and opportunity costs. These will only detract from long-term results, so a good adviser will actively help you stay on track for long-term success during times of market ‘wobbles.’
While 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 has offered investment management services since it was founded in 1979 by current Executive Chairman Ken Fisher. Today we help clients all over the world to create appropriate portfolios and measure performance over time.