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“How am I doing?” is a question I often ask myself. I may check the mirror to make sure I've applied my sunscreen evenly before heading outside. I may evaluate how I feel on a long run to determine whether I need more water. In regard to my finances, I might check my spending or see how my investments are faring.
In the realm of portfolio management, there are many ways to measure an investment portfolio. Right now, I'll look at how to gauge portfolio performance compared to its benchmarks. Here are some steps to consider:
Choose the Portfolio or Account to Be Measured
First, I'll need to decide whether I'm going to look at one investment account, a collection of accounts, or an entire investment portfolio. For example, will I measure the performance of
- one account, such as a 401(k) account?
- a collection of accounts, such as retirement accounts that include a 401(k), IRA, Roth 401(k), Rollover IRAs, etc. ?
- an entire investment portfolio that consists of retirement accounts, college-savings accounts, and investment accounts?
It makes sense to look at an entire portfolio in many cases. But if I want to review how I'm doing when managing my own investments vs. a managed portfolio vs. an investment advisory service, then segmenting various portfolios could work well.
Consider the Asset Allocation
Next, I'd want to consider the asset allocation of the portfolio. Investments could be categorized into asset classes (stocks, bonds) or sub-classes (large-cap stocks, mid-cap stocks, etc.) like these:
- Large-Cap US stocks
- Small-Cap US stocks
- International stocks – developed countries
- International stocks – emerging countries
- US bonds
- International bonds
- Real Estate
For each asset class or sub-class, there is an associated percentage of assets. For example, the asset allocation of a retirement portfolio could be 65% large-cap US stocks; 25% international stocks; 5% US bonds; and 5% cash. Though this may or may not be an ideal or model asset allocation, these percentages represent how the portfolio is invested. I'll use this weighting for my comparison of actual vs. benchmark performance.
I'll need to identify appropriate benchmarks to compare performance of my portfolio with expected performance. The main idea is to match my groupings of investments to an appropriate index.
The S&P 500 comes to mind as I often read comparisons of a stock's performance to this benchmark. But it's unfair to compare the performance of cash and bonds (which are meant to add a layer of safety and income to a portfolio) to that of stocks (which are meant to fuel the growth of a portfolio).
So, it makes sense to find benchmarks or indexes aligned with various asset classes or sub-classes. For example, I'd match large-company stocks in the United States to the S&P 500 while U.S. bonds could be matched with the Bloomberg Barclays US Aggregate Bond Index.
There are loads of indexes from which to choose. Here are benchmarks (market indexes) to consider:
- Large-Cap US stocks: S&P 500
- Small-Cap US stocks: S&P SmallCap 600 or MSCI USA Small Cap
- International stocks – developed countries: S&P Developed Ex-U.S. BMI or MSCI World
- International stocks – emerging countries: MSCI Emerging Markets
- US bonds: Bloomberg Barclays US Aggregate Bond Index
- International bonds: Bloomberg Barclays Global Aggregate Bond Index
- Real Estate: S&P United States REIT or S&P Global REIT
Calculate Actual vs. Benchmark Portfolio Performance
Now I'll calculate the performance of my portfolio and that of its benchmarks. Let's say I'm looking at my retirement portfolio and, to keep things simple, I'll pretend that I didn't make any contributions or take any distributions in a particular year.
For this illustration, my hypothetical portfolio comprised of individual stocks and bonds has grown from $600,000 to a bit more than $660,000. That's a 10% investment growth or return. Here's how that may have happened to my portfolio:
- U.S. Stocks: 65% of $600,000 x Growth of 11% = $432,900
- International Stocks: 25% of $600,000 x Growth of 12% = $168,000
- U.S. Bonds: 5% of $600,000 x Growth of -2% = $29,400
- Cash: 5% of $600,000 x Growth of 0% = $30,000
- Total: Growth of $600,000 into $660,300
Now, I'll compare my portfolio's performance to its benchmarks. Let's say the benchmarks had these returns during the same year my portfolio grew by 10%:
- S&P 500: 14%
- S&P SmallCap 600: 20%
- S&P Developed Ex-US BMI: 19%
- Bloomberg Barclays US Aggregate Bond Index: 2%
- Bloomberg Barclays Global Aggregate Bond Index: 4%
- S&P US REIT: -9%
- Cash: 0%
If I could have achieved benchmark returns, my portfolio would have grown like this:
- U.S. Stocks: 65% of $600,000 x Growth of 14% = $444,600
- International Stocks: 25% of $600,000 x Growth of 19% = $178,500
- U.S. Bonds: 5% of $600,000 x Growth of 2% = $30,600
- Cash: 5% of $600,000 x Growth of 0% = $30,000
- Total: Growth of $600,000 into $683,700
In total, my portfolio would have grown to $683,700 or about 14% [($683,700 – $600,000) / $600,000)].
So, in this year, the “actual” portfolio didn't do as well as it should have, given the performance of various economies as represented by the benchmarks.
Note that this portfolio and these returns are hypothetical and simply serve as a way to discuss the calculation of portfolio performance. In addition, index funds or ETFs may have slightly different holdings than their benchmarks and charge investors for their services, leading to different results. For example, instead of getting a 19% return with an international stocks fund, I may get 17% because of fund operating expenses or tracking errors (the deviation between benchmark and fund holdings). Further, this example is not meant to suggest that index funds always outperform individual stock selections.
The main idea is that when I ask myself “how I am doing?,” I should consider benchmarks associated with various asset classes.
How do you measure the performance of your portfolio?