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Evaluating Your Investment Returns



According to David Fabian, “A vital part of Investment success depends upon one’s ability to compare historical returns with an index or benchmark.

Doing so will let you measure if your approach meets the performance expectations or evaluate the efficiency of somebody else’s recommendation prior to hiring them. Although is may be very common in the entire industry, many investors still make knee-jerk conclusions based on unreliable or biased information.

Two primary conditions that must be satisfied when determining the viability of any investment approach are discussed below:

A proper standard of evaluation

We now lay down the reasons why these concepts are essential to your decision process.

Let us talk about time.

In reality, time is a commodity that has lost its overarching value in the fast-evolving dynamics of our daily existence. People so often fall prey to the temptation of immediate gratification provided by modern technology that they totally overlook how much time is required to accumulate wealth through the process of compounding.

For instance, if you start saving and investing starting at your mid-20’s and then you retire in your mid-60’s; it would have taken you 40 years to accumulate your wealth. But it does not end there. You need to sustain your wealth’s security for another 20 years through managing and conserving your investable assets. The growth period alone will take 480 months or 40 years, while the distribution or income period could last for 240 months or 20 years more. You need enough patience to see it through.

You cannot simply compare returns over very short time-durations. That is why you can hear people cry: My portfolio has been stagnant in four months! I’m below the benchmark on a 6-month rack record! Alas, my portfolio is 250 basis points lagging from the S&P 500 this year – I am done for!

The truth is that even the most efficient investment method will suffer some setbacks through underperformance. It may take some months or even last for a couple of years or more at a time. The best step to take during such doubt-filled or self-pitying moments is to recall why you chose this strategy in the first place.

Is your investment strategy still consistent with your risk tolerance level?

Could there be an intervening and temporary factor that is causing the adverse conditions?

Can you do something to manage this factor in order to enhance your long-term returns?

Have you really considered the risks of shifting to another approach in mid-stream?

Experts would advise that you analyze the performance of any investment method over a period of 3 to 5 years, enough time to determine the strengths and weaknesses over several conditions of the markets (bear, bull, transitional, and others).

The bond or stock markets can proceed for a few years along a particular direction. While that may favor some investors, it can also hurt others. Not that either side is bad investing; it all has to do with each group being exposed to different risks.

Creating and protecting your wealth is not a 100-meter dash -- a short-distance race, so to speak. Rather, it is a marathon -- a sustained race where risk conditions must be considered at close-range and behavioral principles applied with accuracy. Great patience is, therefore, of utmost importance in order to succeed as an investor. There are no short-cuts in this industry.

A Suitable Benchmark

A common pitfall among investors is the tendency to compare apples and oranges.

A prime example is that of a company whose primary approach is to have a mix of bonds and stocks allocated through ETFs that are adjusted according to meticulously-developed strategies. As such, it has a total of 20 to 40% stocks and 50 to 70% bonds in the Strategic Income Portfolio at any particular period.

However, the most common feedback the company derives when evaluating performance is how its portfolio stacks up against the S&P 500 Index. It seems that people are programmed to think that the S&P is the singular reliable benchmark available, such that it has become the darling standard of many index lovers throughout the world.

Obviously, there is no basic logic to comparing the returns of a 100% stock portfolio (the S&P 500) versus a multi-asset portfolio that contains less than 50% exposure in stocks. A better and more suitable benchmark for such a type of investing method would be the 40/60 allocation in the iShares Core Moderate Allocation ETF (AOM). That is where the data will exhibit a clearer picture of actual performance.

In a similar manner, comparing the 0 to 60 mph rate of starting acceleration of a Porsche in a few seconds to that of a Suburban would not make sense either, would it? Although that is an accepted truth, in general, only a few investors consistently apply that universal principle in their investment practices.

It is vital to appreciate that fundamental concept in the process of accurately measuring risks or comparing similar approaches.

Never compare investing in bonds and stocks to the revenues of a CD or a money market account.

Never relate a portfolio of technology stocks to closed-end funds.

And never compare hedge-fund revenues to that of a bunch of ETFs.

We can continue down the line. . . .

Perhaps, the most difficult hurdle to making this logical conclusion is the fact that most investors do not know the suitable benchmark for comparison objectives or where to locate them. They merely gravitate to the S&P 500, the NASDAQ Composite or the Dow Jones Industrial Average because they see them flashed on the news or on the web daily.

In the end, every particular asset type or investment instrument should be weighed or evaluated by a similar group of equals. ETFs have made that process less difficult for many years now; however, you must always undertake the task of finding an appropriate index to serve as a benchmark. Ask a professional analyst how and where to find a good benchmark as a reliable yardstick.

The Ultimate Goal

Investing involves a lot of psychology and comprehension of the relationship of certain facts and information. This article hopes to develop a new perspective not considered previously or to strengthen an existing point-of-view. It is hoped that either way, the reader will attain a more reliable and more solid frame of reference for evaluating a portfolio’s performance in the future.

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