In Part One of our series on Why Your Investments Are Terrible, we talked about the importance of understanding what you’re invested in and why. Here, in Part Two, we’re focusing on performance.

Measuring your portfolio’s performance seems pretty straightforward. I mean, if your portfolio returns have gone up for the year that’s good and if they’ve done the opposite, that’s probably bad…right?

Short answer: Not exactly…

Here’s another way to think about it. Let’s say you went to buy a brand new car and found a great deal at the first dealership you visited. You anticipated paying no more than $25,000 and drove away having paid $20,000.

A good deal, right?

A few days later, you learn that the new car you just bought was only worth $15,000 and all of the dealerships — except the one you bought from — were selling it for that amount.

At first glance, saving $5,000 on your purchase was a win. However, when compared against the underlying value, you didn’t fare nearly as well.

Chances are, you’re taking the same approach to measuring the performance of your portfolio.

By looking only at the raw returns (whether your portfolio is up or down, and by what percentage), you’re neglecting a very important measurement in determining your portfolio’s true performance.

So, how do you really know whether a number (purchase price, investment return, etc.) is good or bad? You don’t unless you have something relevant to compare it to.

Getting Started

In the first post we asked you to have your statement handy as you were reading through the details, so let’s pull those out again as we’ll need them to get an idea on how well your portfolio is really performing.

Somewhere near the top of your statement, you should find the total performance for your whole portfolio. Can you find it? If so, hold on to that number…we’ll revisit it in just a sec. If it’s not there, it should be and you should probably consider this a blaring red flag.

Now, we’re not saying that your financial advisor is hiding anything, but honestly, having the performance of your portfolio easily explained and near the top of your Account Summary shouldn’t be too much to ask.

I know what you’re probably thinking, “My advisor is a great person, I like him/her.” “And just because I don’t fully understand what they’re doing (from a performance perspective), doesn’t mean they’re a bad person.”

And you’re right, no argument from me there. But, you should demand BOTH a great subjective relationship with your advisor and a great objective relationship (performance). Great service shouldn’t come at the expense of performance. Know that you’re getting both.

But I digress!

For those of you who were able to find your performance over real time frames (ex: 1 yr, 5 yr, lifetime), with reasonable comparison to a similar index (aka: benchmark – which we will cover in more detail momentarily), hats off to you! You (and your financial advisor) have done a great job.

There’s still more to the story, though.

The Importance of Comparison

A lot of the published advice that you read online or in the newspapers related to overall returns is completely irrelevant to your situation. That’s largely because it compares those returns to portfolios that aren’t remotely similar to yours.

For example, because the S&P 500 is so well publicized, it is often used as a gauge of success (or benchmark), for many different types of investment portfolios.

The problem is, the S&P 500 is an index made up of 500 different stocks. That means, if your portfolio is not made up of 100% stocks, and instead is composed of many different assets (stocks, bonds, etc.), a comparison against the S&P 500 is not helpful in the least.

The solution: find the right benchmark for your portfolio.

For every type of investment there is an index that can serve as an appropriate measuring tool. Find an advisor that provides these comparisons on their quarterly reports so you can fully understand how you’re faring throughout your portfolio.

For example, we utilize a universal benchmark on all of our clients statements that consist of 50% global stock market index, 50% short term high quality bonds. This is a middle of the road mix that allows our clients to compare their performance, with the understanding that they should expect their performance to be higher if they have a higher proportion of stocks and lower if they have a lower proportion of stocks (because stocks have more risk).

Getting the Full Picture

Our position is that the proper way to look at performance is relative, not absolute.

For example, if your portfolio went up 30% but the relevant asset classes/benchmark went up 40%, your 30% isn’t good!

Likewise, if your portfolio went down 10% but the relevant benchmark went down 25%, you’ve done well and should be very happy!

Behold the power of benchmarking!

By now I hope you understand how viewing your performance through the lens of a benchmark helps you get the full picture and avoid operating in a vacuum. Given that insight, it’s easy to see why just looking at your portfolio’s raw returns is an ineffective way to understand performance.

Of course, we’re not done discussing your portfolio and everything standing in the way of it reaching its full potential. So, be sure to check back in two weeks where we’ll continue the conversation and dig into the contents of your portfolio and determine if there’s any rhyme or reason to your composition.

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