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?
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
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.
-
Stock Market Today: Stocks Close Mixed Amid War Angst, Nvidia AnxietyMarkets went into risk-off mode amid rising geopolitical tensions and high anxiety ahead of bellwether Nvidia's earnings report.
-
What the Comcast Cable Spinoff Means for InvestorsComcast has announced plans to spin off select cable networks and digital assets into a separate publicly traded company. Here's what you need to know.
-
For a More Secure Retirement, Build in Some 'Safe Money'To solidify your retirement plan, write it down, reduce your market risk and allocate more safe money into your plan for income.
-
Five Steps to a Mindfully Fearless CareerIf, like many women, you're struggling with imposter syndrome, try developing an athlete's winning mindset. It's as simple as facing one small fear every day.
-
Six Ways to Optimize Your Charitable Giving Before Year-EndAs 2024 winds down, right now is the time to look at how you plan to handle your charitable giving. The sooner you start, the more tax-efficient you can be.
-
How Preferred Stocks Can Boost Your Retirement PortfolioHigher yields, priority on dividend payments and the potential for capital appreciation are just three reasons to consider investing in preferred stocks.
-
Structured Settlement Annuity vs Lump-Sum Payout: Which Is Better?As the use of structured settlement annuities grows, it can be tough to decide whether to take the lump sum to invest or opt instead for guaranteed payments.
-
What to Do as Soon as Your Divorce Is FinalDon't delay — getting these tasks accomplished as soon as possible can help you avoid costly consequences.
-
Many Older Adults Lack Financial Security: What Can We Do?Poor financial literacy and a lack of foresight have led to this troubling reality. It's going to take tax policy changes, education and more to address it.
-
Winning Investment Strategy: Be the Tortoise AND the HareConsider treating investing like it's both a marathon and a sprint by taking advantage of the powers of time (the tortoise) and compounding (the hare).
