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SMART INSIGHTS FROM PROFESSIONAL ADVISERS

How Should YOU Measure Your Investment Performance?

Investors shouldn't be obsessed with their portfolio's performance, but an annual evaluation is key to keeping you on track.

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I’ve spent over 25 years in the financial advisory profession but recently had a startling realization about investment performance. During a friendly debate with a friend who manages a small-cap mutual fund, I realized even seasoned investment professionals can have misperceptions about investment performance. My friend had a fixation on top quartile performance, a key measure of his professional ranking, but one with little application in the real world — where clients typically own mutual funds representing various asset classes.

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Our debate got me to thinking: How should the average investor measure investment performance? I recommend investors focus on two components of performance:

How is my performance number calculated?

How is my account doing relative to a fair benchmark?

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Your Performance Calculation

The performance calculation methodology involves two key variables: 1) the mathematical formula used to produce a return figure and 2) the portfolio(s) that are being measured. Most professional money managers use a Global Investment Performance Standards (GIPS) compliant methodology to calculate investment performance. Brokers, Registered Investment Advisers and custodians often provide performance information to clients in their account statements. It is important to ask your provider if their performance report uses an approved GIPS methodology. Time-weighted returns are the most commonly used measure.

Interestingly, GIPS does not require investment performance to be reported net of fees. Consumers would be wise to ask their adviser for performance reports net of fees. After all, it’s not what you earn, it’s what you keep that is important.

Equally important is understanding whether the performance number is specific to your account, or merely a listing of the performance of each mutual fund. According to the GIPS guidance statement on fees, “The GIPS standards are based on the concept of presenting composite performance to prospective clients rather than presenting individual portfolio returns to existing clients (emphasis added).” Very simply, it is permissible for a broker or custodian to show a performance number on your statement for XYZ mutual fund that may or may not be your actual investment performance.

I’ve seen brokerage statements list a client’s various mutual fund’s performance, but not include the client’s overall account performance. Investors should ask their adviser for their specific account’s performance net of all fees. Most advisers have software that can calculate this.

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Which Benchmark to Use

What about benchmarks? How can investors gauge their performance relative to other alternatives? This simple question raises many issues.

Should you benchmark your portfolio versus an index like the S&P 500? What’s a fair comparison for a portfolio invested 65% equity / 35% fixed? What about an all-equity portfolio comprised of large-cap, small-cap, international, REITs and emerging markets?

Morningstar provides a quarterly list of average returns by category, which is a reasonable basic benchmark to measure a specific fund. For accounts using a diversified, multiple asset class approach, Morningstar provides returns for different asset allocation funds, sorted by equity ranges. This is a helpful guide should your portfolio be comprised of large-cap, small-cap, international and emerging market funds.

The Bottom Line

While an obsession with performance can be counterproductive (often leading to chasing past winners and inferior performance), an annual review of portfolio performance is something all investors should undertake. Make sure you understand what is being measured and how it is being measured so you can track progress toward your goals.

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Mike Palmer has over 25 years of experience helping successful people make smart decisions about money. He is a graduate of the University of North Carolina at Chapel Hill and is a CERTIFIED FINANCIAL PLANNER™ professional. Mr. Palmer is a member of several professional organizations, including the National Association of Personal Financial Advisors (NAPFA) and past member of the TIAA-CREF Board of Advisors.

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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.