investing

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.

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.

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?

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.

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.

About the Author

Mike Palmer, CFP

Managing Principal, Ark Royal Wealth Management

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.

Most Popular

Senate Passes $3,000 Child Tax Credit for 2021
Coronavirus and Your Money

Senate Passes $3,000 Child Tax Credit for 2021

The provision would temporarily increase the child tax credit to $3,000 or $3,600 per child for most families and have 50% of it paid in advance by th…
March 6, 2021
Senate Passes Bill with More "Targeted" Stimulus Payments
Coronavirus and Your Money

Senate Passes Bill with More "Targeted" Stimulus Payments

The Senate finally passes the $1.9 trillion COVID-relief bill. But fewer people will get a third stimulus check under the Senate version than under th…
March 6, 2021
Your Guide to Roth Conversions
Special Report
Tax Breaks

Your Guide to Roth Conversions

A Kiplinger Special Report
February 25, 2021

Recommended

Are You Going to Run Out of Money in Retirement?
retirement planning

Are You Going to Run Out of Money in Retirement?

A portfolio stress test can help give you some peace of mind about that … but if you’re not careful, it could give you a false sense of security. To g…
March 8, 2021
The Cost of Retirement Has Tripled! But a New Way of Planning Can Help
retirement planning

The Cost of Retirement Has Tripled! But a New Way of Planning Can Help

With today’s low interest rates and paltry dividends, the old way of saving for your retirement and living off your dividends and income to preserve y…
March 5, 2021
The Basics of Required Minimum Distributions: 12 Things You Must Know About RMDs
Financial Planning

The Basics of Required Minimum Distributions: 12 Things You Must Know About RMDs

Retirement savers who are 72 must start withdrawing funds from tax-advantaged retirement accounts. Here’s what you need to know about required minimum…
March 4, 2021
A COVID Storm Hits Senior Living
Coronavirus and Your Money

A COVID Storm Hits Senior Living

The pandemic has created significant challenges for all types of senior living communities. Because of that, it's more important than ever to review a…
March 3, 2021