Gauging the results of your investments should be part of your total investment strategy. If you are doing well, keep doing what you are doing. If your results are not measuring up, consider making changes.
What to Measure
Absolute performance — Simply stated, this is just a measure of how much your total portfolio increased or decreased during a period. If you started with $50,000 at the beginning of the year and it is worth $60,000 at the end of the year. Your portfolio increased by 20%. The difficulties lie in measuring how well that performance compares to the overall market and what if you made additions to your portfolio or took withdrawals.
Relative performance — Comparing your return to the overall market is a better measure. If your total portfolio is up 20% for the year and the overall market is only up 15%, you have done very well. Or if your portfolio is down 10% and the overall market is down 15%, you have done well. But, what if you built your portfolio to be more or less risky than the overall market. Also, what if you make additions or took withdrawals?
Current returns — Many people are interested in how much current income their portfolio is producing. Looking at the income, comprised of dividends and interest received, is important if you are using the current income to help with your living expenses. However, the level of income is probably most determined by what type of investments you own. If current income is important, a portfolio of fixed income securities (bonds and money market funds) and higher paying stocks (utilities and perhaps real estate investment trusts) can produce income but only with a probable reduction in the upside capital gain potential found with a broader stock portfolio.
Taxable income — Investment portfolios produce taxable income in the forms of dividends, interest and
capital gains. However, this is probably not a true indication of how well your portfolio is performing
because you control the dividends and interest through your selections and you control the capital gains
by deciding when to sell the securities.
What to Compare
Having an appropriate basis of comparison can be just important as using the right type of performance measure. Ideally, you should select a comparison measure that has characteristics similar to your portfolio.
The most common measure of equity performance is the S & P 500 index. This broad and often quoted index measures the performance of the 500 largest publicly traded companies. It is a good measure to use if your stock portfolio is broadly diversified. If your portfolio is comprised of mostly smaller companies, you may want to use the NASDAQ index or the Wilshire 5000 index. They include smaller companies and represent a larger base.
For your fixed income investments, you may want to compare the returns of long-term U. S. Government
bonds. This measure is a bit more difficult to find, but is usually included in many quarterly and
annual reports issued by market commentators.
It is a Long-Term Process
Managing your investment portfolio is a long-term process. Understanding how well you are doing can help you evaluate your selection process, how well your advisor’s selections are doing and whether you should change your process or select a different advisor.