Choosing the right investments for your goals is just the beginning.  You need to monitor their performance to see how you are progressing towards those goals.

Many times investors look at their statements and check out the investment return.  If the total has increased by say, 7 percent, from the last statement, they’re happy.  On the other hand if their portfolio has lost 7 percent, they may be tempted to move on to something else.

Related: My 2013 Portfolio Rate Of Return

To assess how well your investments are actually doing, though, you need to evaluate performance against an appropriate benchmark.

What is a benchmark?

A benchmark is an objective standard against which the performance of an investment can be measured.  Market indexes are the most widely accepted performance benchmarks and these are the most cited in the investment industry.

A benchmark index is comprised of the same or similar types of investments as are found in your portfolio.

How is your portfolio manager doing?

You may have noticed on your statement that your mutual fund performance is compared to a similar market index.  Comparing returns to a benchmark is a way to measure the portfolio manager’s skill and to see if any value is being added relative to the fees being paid.

Related: Fund Facts About Mutual Funds

The difference in returns is called the tracking error.  A low tracking error means the portfolio closely follows its benchmark.  If it is high, it could suggest that additional risk is being taken to achieve certain returns.

You want to know if your fund manager is good, or is just investing in a hot market that makes him or her look good.

Compare apples to apples

To evaluate your portfolio’s performance you need to find the appropriate benchmark, or you’ll end up drawing the wrong conclusions.  Look for the benchmark that tracks the investments that are the most like yours.  With a diversified portfolio you may have to use more than one.  Here are some examples:

  • For bonds use DEX Universe Bond Index
  • For broad based Canadian equities use S&P/TSX Composite or S&P/TSX Composite Total Returns Index (includes dividends)
  • For Blue Chip stocks use S&P/TSX 60 Index
  • For US Blue Chip equities use S&P 500 stock index
  • For Global equities use Morgan Stanley World Index (MSCI)
  • For International equities use MSCI Europe Australasia Far East Index (EAFE)

You can find a complete list of worldwide indexes here.

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Compare your returns over the long term, such as a period of 5 to 10 years.

If the market is strong but your portfolio value has remained flat, you may want to look more closely at your individual investments.  Yet if your portfolio is slumping when markets are falling it may simply be reflecting market conditions.

Conclusion

Let’s go back to our fictional investor above.  He may not be as pleased to find his 7 percent return compares to a 12 percent market index return – it has underperformed.  Likewise, he should be somewhat happier with his 7 percent loss when he learns that the market dropped 12 percent – it has actually outperformed the market.

Regularly measure and monitor not only your portfolio’s actual annual rate of return, also compare it to a specific benchmark.

Related: 5 Challenges DIY Investors Face

Without this step, how do you know if your investments are meeting your goals?


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