How Are Your Investments Performing?
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
How are your investments performing? 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.
Related: When To Fire Your Investment Manager
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.
How are your investments performing?
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?
Short but sweet post.
You touched on it but I think its the number 1 confusion in measuring portfolio performance is distinguishing between price returns and total returns, once you’ve got past the initial barriers of deciding what index to use etc.
If you use a price return index i.e. S&P/TSX Composite Index you do not want to compare it to your portfolio including dividends. You will likely show a incorrect outperformance as your benchmark index isn’t factoring dividends in to return.
If you use a total return index i.e. S&P/TSX Composite Total Return Index you will want to include dividends in your portfolio return.
Why use one over another? Total return data is usually tricky to find on a daily basis so you can use the price return index. But total return gives you a true representation on how your portfolio is doing compared to the index.
If you are having trouble finding total return data its readily available on the ishares website for indexes ishares ETFs track.
Hope this helps – Kathy Waite
Finding the right benchmark for some funds may be difficult. For example within Canadian stocks in general you could choose a large cap, small cap, value, or growth index. The fund may not make it easier since I’ve heard that many funds choose the wrong index as their benchmark.
A study I saw recently showed that many funds’ performance is explained simply by comparing them to the right max of indexes, which hold similar stocks and end up having similar returns. I’m not sure if this accounts for managers shifting between different styles of stocks over time, which a benchmark never does.
This is a great post for those who need to reality check their investments. I would also suggest that anyone with a mutual fund take a look at the appropriate index, but they’ll probably be shocked at how poorly they are doing.
I don’t agree that you need a benchmark to compare your portfolio against although I agree you need a target that is realistic and calculate your ROR.
If you reach your target but you are short of an index, what do you do? Start chasing the index? Your portfolio is based on as strategy, targets and goals and not on an index performance. While you can use an index it doesn’t mean you need to change your strategy. However, most will have a hard time not sticking to their strategy and start shifting their portfolio to chase the benchmark they missed … Just buy the index if that’s what you want, otherwise ignore the index.
Index comparisons are not that simple unless you are setup to track the indexes based on your purchases. You can look at any reports on the 2013 index performance but it goes up and down and your performance against the index is based on when you add your money. In short, you need to do double accounting against your portfolio and the index you want to compare against. Some brokers or software will do that for you.
I also think that you need at least 5 to 7 years of data to effectively compare a strategy to an index. It’s a full cycle from recession to recession and it shows how well you do in the ups and downs. Your strategy might not be strong in a bull market but it might not struggle in a bear whereas the indexes bounce up and down. That’s why the equity index risk is offset by having bonds. Someone who start investing during a bear will do better than someone who start during a bull … It’s simple math. You lose money early, and it takes longer to make it back.
Index benchmark were put in place to remunerate the fund managers in the first place … They end up manipulating their funds towards the end of the year to make or break the targets. If the index matters, buy the indexes and call it a day.