Most people prefer good news over bad, which may explain why you’re more likely to check the value of your investment portfolio when the stock market is on an upswing, rather than during a downturn. But in some cases, you may be disappointed if you find that your portfolio’s value isn’t keeping pace with stock market gains. While that feeling is understandable, you also need to make sure you’re measuring performance correctly.
Investors typically own a diversified mix of investments, which may include domestic and foreign stocks, short- and long-term bonds, commodities, cash, and alternative investments. Therefore, when measuring the overall performance of your portfolio, you first need to evaluate the performance of each component relative to its respective benchmark index.
For example, many actively managed U.S. stock mutual funds use the S&P 500 Index as their benchmark. Alternatively, a fund that invests in international stocks might benchmark against the MSCI EAFE Index, while a bond fund might use the Barclays Capital Aggregate Bond Index.
If you want to know how your fund has performed relative to its benchmark, examine its returns over various time periods, such as one year, three years, five years, 10 years, or the life of the fund. This information can found on the fund company’s web site or in the fund’s prospectus and shareholder reports.
Keep in mind that unlike passively managed vehicles, such as index funds or exchange traded funds (ETFs), actively managed funds seek to outperform their benchmark index. Most funds will experience periods when they lag their benchmark due to the performance of individual securities or market sectors in which funds are over- or underweighted. But hopefully the fund will outperform its benchmark over longer periods.
If you find that a particular holding has trailed its benchmark for many years, this may be cause for concern and for making a change. Similarly, if you own index funds or ETFs that are trailing their benchmark indexes by a margin greater than their expense ratios, a phenomenon known as “tracking error,” you may want to reassess that particular holding.
For many investors, evaluating the performance of their investments relative to other investments or a benchmark index is less important than understanding the bigger picture. They simply want to know how much the value of their portfolio has grown — a measure known as absolute return.
In fact, some financial advisors provide performance reports that show your absolute returns year-to-date and over longer periods. It’s then up to you to decide whether your portfolio’s performance is meeting or beating your expectations. This will depend on your stated goals and risk tolerance. If your goal is to generate income, then it may be less critical for your returns to keep pace with the stock market. On the other hand, if your goal is aggressive growth and your portfolio is lagging the broad market over long periods, it may be time to reassess your strategy.
View in light of the big picture
If you haven’t measured your portfolio’s performance recently, be sure you keep the big picture in mind. Your financial advisor can offer perspective on the individual components of your portfolio and your overall investment strategy, and explain how to measure performance.