One of the easiest ways to lose weight is to weigh yourself every day. Many people report dropping pant sizes simply by getting into the habit of standing on a scale regularly, probably because it subconsciously motivates you to reduce your portion sizes, choose healthier foods, and opt for the stairs instead of the escalator.
But you can’t look at your changing body weight in isolation: it’s possible to lose weight and put on fat at the same time. The same is true when monitoring your portfolio’s progress. Knowing you earned 10% doesn’t tell you much unless you know the context: if your benchmark returned 15% during the same time period, you should be concerned. Meanwhile, losing only 5% when your benchmark lost a whopping 10% could be cause for celebration.
In order to track your investment progress properly, you need to look at a number of variables. Your annual rate of return is the starting point, but even that seemingly simple number is hard to track down.
Rhea Plosker, an engineer from Toronto, faced some hurdles getting performance numbers from her adviser. “I insisted that my investment adviser provide me with the rates of return for my investments over the three years I had worked with her. Her firm did not, as a policy, provide rate-of-return reporting. After pulling teeth to get the report, I realized that, after fees, my returns were very poor,” she says. Plosker wasn’t familiar with the concept of portfolio benchmarks at the time, and she admits to being “blissfully ignorant” about how she was doing.
If you have an adviser, you should ask them to provide you with your personal rate of return on an annual basis. They shouldn’t just hand over the latest fact sheets for your mutual funds, because how your portfolio performs and how the underlying investments perform can be two totally different things.
For example, let’s say you deposited $10,000 into Mutual Fund A when you received your tax refund in May. By the end of the year, the fund may have reported a 10% return for the calendar year, but if most of the increase came between January and April, you would have seen none of those gains. Your adviser should provide a dollar-weighted return (or “internal rate of return”), which factors in any deposits or withdrawals you made during the period.
Once you have figured out your returns, you need to compare them to an appropriate benchmark. You should compare your Canadian equity returns to those of an index such as the S&P/TSX Composite, your U.S. equities to an index such as the S&P 500, and your bond portfolio to the DEX Universe Bond Index. Your overall portfolio benchmark will be a weighted average of these indexes.
Let’s say your portfolio is half in Canadian stocks and half in bonds, with an annual return of 7.5%. That same year the S&P/TSX Composite Index returned 11% and the DEX Universe Bond Index returned 7%. Your custom benchmark return would be (50% x 11%) + (50% x 7%) for a total of 9%. On the surface, it looks like you underperformed, but you have to factor in the cost of having an adviser (1% is reasonable) and the cost required to track the index (about 0.25%). Remember, investment products and advice are never free: even Couch Potato investors don’t get the full index returns, so in the real world you should expect to lag your benchmark slightly.
So if you subtract 1.25% from the benchmark return of 9%, you get 7.75%. You’ve still underperformed by 0.25% in this case, and over a one year period, this isn’t too bad. But had you been underperforming by a few percentage points over a number of years, it would be time to start asking some questions. Is the adviser’s cost worth it? Perhaps you like the planning services, but the investments need an overhaul. Or maybe they both need to be revisited.
If you are a DIY investor, measuring your performance is also crucial, or you’ll have no idea whether your strategy is working. Unfortunately, the calculations are not easy, so you’re going to have to roll up your sleeves to figure this out. For a full explanation of how to calculate your portfolio returns, see “How you doin’?” in our June 2012 issue.