You’ve done your research, completed your due diligence, and made your investments. From stocks and bonds to startup investments and crypto, you’ve assessed your risk and crafted a diverse portfolio of capital assets. But as an investor, all that work is just the beginning. Now it’s time to track how your carefully curated portfolio performs.
Fine-tuning Your Portfolio
A good investment strategy is never finalized – it needs continual fine tuning. To do this, you’ll need to monitor your portfolio’s performance over time. Are your selected investments working together to drive you toward your financial goals? Even if some of your investments have decreased in value, is the overall value of your portfolio increasing?
If your investments aren’t experiencing gains, or if they’re decreasing, you’ll want to root out the cause to inform your next steps. Similarly, it’s prudent to keep an ear to the ground for new opportunities that could potentially bolster your portfolio’s performance, trim under-performing investments, and rebalance when needed. However, to do this, you’ll need to know how best to measure each of your investments.
Assessing Your Investments
Using the broadest definition possible, an investment return measures the performance of an investment between two points in time. “Stock in the Acme Anvil Company returned -5% in 2018” may not inspire confidence, but you’re going to need more information to evaluate a hypothetical investment in this hypothetical company.
What exactly does that -5% mean?
Investing is a numbers game, and it’s vital that an investor understand exactly what performance numbers measure. At what price did Acme stock open on 1/1/18 and close on 12/31/18? Did they pay any dividends during the year? Were there any stock splits? Was there a return of capital?
Return is generally expressed as either price return or total return, and total return offers a more nuanced representation of how an investment in a particular stock actually fared during a given time period.
The examples below are provided for illustrative purposes and do not consider transaction fees, inflation, or specific tax circumstances, which are all important aspects of a comprehensive individualized investment portfolio evaluation.
Price Return (or more simply “return”) reflects price movements only. If you’re considering a short-term investment or trying to capitalize on current market price fluctuations, evaluating various price returns may be valuable.
Price Return = – 1
Total Return reflects both price movements as well as the reinvestment of any income such as interest, dividends, or other distributions. This is generally a more useful calculation for investments held longer-term and/or those for which you believe distributions will be paid.
- Gross Total Return reflects reinvestment of income without consideration for withholding taxes applicable to regular cash dividends.
- Gross Total Return = – 1
- Net Total Return reflects reinvestment of income after the deduction of withholding taxes applicable to regular cash dividends.
- Net Total Return = – 1
What’s your benchmark?
An integral part of deciding to maintain, add to, or trim an investment should be an evaluation of that investment’s performance versus an applicable yardstick. This could be as broad as the U.S. stock market, or you can be more granular and choose an industry or sector-specific benchmark. Commonly used benchmark companies in the investment industry include:
It’s important to make sure that the indices used to evaluate investment performance are applicable. For example, it does not make sense to compare the performance of a portfolio comprised of corporate bonds, municipal bonds, and German Government Bonds against the Dow Jones Industrial Index, which is comprised of U.S. stocks. Additionally, the performance of some asset classes – such as equity in private companies – does not always correlate with the performance of publicly-traded equity markets. Cambridge Associates is one company that indexes private equity investment, but the challenges in valuing private equity make for a more complicated assessment.
A few assumptions and a little math help pull it all together.
- You bought 10 shares of Acme Anvil Co. on 1/1/18 for $100 per share;
- Acme Anvil’s highest share price in 2018 was $110 on 3/31/18;
- Acme Anvil paid a year-end dividend of $10/share, meaning you received $100;
- Acme Anvil’s share price at the close of business 12/31/18 was $95; and
- You’re subject to a 15% dividend withholding rate.
A shorter term investment: If you purchased on 1/1/18 at $100 and sold 3/31/18 at $110 (before any dividends were paid), your price and both total return figures for this hypothetical investment would be 10%. “Stock in the Acme Anvil Company returned -5% in 2018” isn’t useful in this context.
- Price Return = – 1 = 0.10 or 10%
A longer term investment: If you purchased on 1/1/18 at $100, collected the year-end dividend, and still held the shares 12/31/18 at $95, your price return, gross total return, and net total return and total return figures would be -5%, 5%, and 3.5% respectively.
- Price Return = – 1 = -0.05 or -5%
- Gross Total Return = – 1 = 0.05 or 5%
- Net Total Return = – 1 = 0.035 or 3.5%
Now you can see that the -5% initially referenced only reflects a portion of Acme Anvil’s 2018 performance. The positive numbers that include the dividend are obviously a step in the right direction, but investors should see what the rest of the market looked like during the same period.
There are any number of indices to which an investor can compare the performance of a single investment or an entire portfolio. For this example, we’ll use the S&P 500Ò Index, which measures the performance of the large-cap U.S. equity market, and one of its sub-indices, the S&P 500Ò Industrials Index.
|2018 Total Return|
|2018 Price Return||Gross||Net|
|Acme Anvil Co.||-5.00%||5.00%||3.50%|
|S&P 500Ò Index||-6.24%||-4.38%||-4.94%|
|S&P 500Ò Industrials Index||-15.00%||-13.29%||-13.81%|
Again, context is key. In this example, even the negative price return of the hypothetical Acme Anvil Co. compares favorably to both the performance of the domestic equity market and the more granular industrial sub-index.
Annualized Return – comparing apples to apples. The above examples work neatly because we’re looking at an investment in a single company. What if you were also a long-term investor in the (hypothetical) ABC Corporation?
- You bought 20 shares on 1/1/15 for $75 per share;
- They paid one dividend in 2015 – $0.16/share – meaning you received $3.20;
- The share price at the close of business 12/31/18 was $95; and
- You’re subject to a 15% dividend withholding rate.
Annualizing the return of this second company is key in comparing the performance of the two investments. You’ll first determine net total return for the entire investment period:
- Net Total Return = – 1 = 0.2685 or 26.85%
We’ll need to annualize the 26.85% achieved over a four year period in order to properly compare it to the 3.5% achieved by Acme Anvil in 2018. We start by dividing the number one (1) by the total number of years of returns (4). Then raise the overall investment return to this power, and subtract one from the result.
- Annualized Net Total Return = [ ( 1 + Net Total Return ) 1/Time in Years ] – 1
- Annualized Net Total Return = [ ( 1 + 0.2685 ) 1/4 ] – 1 = 0.0613 or 6.13%
Deciding to keep ABC Corp or Acme Anvil will ultimately be a function of multiple factors, including investment time horizon, ability to tolerate risk and volatility, and individual investment goals. Perhaps Acme Anvil’s more modest 2018 total return is offset by a history of dependable and generous dividend payments – which brings us to yield.
Disability and retirement can reduce or eliminate income previously generated via paycheck. Changing life circumstances are a good time to review your investment portfolio and evaluate its potential to generate income. Yield is the measure of the income an investment pays during a given period of time (usually a year), divided by the price of the investment. Most often, it’s expressed as a percentage. Dividend-paying stocks, bonds, certain mutual funds, and depository bank products such as savings accounts and certificates of deposit (“CDs”) have yields. It’s important to note that payment of dividends and interest (income) is never guaranteed. An investment instrument may have a zero, or in some rare cases, a negative yield percentage.
Yield for stocks is determined by dividing the current year’s dividend by the stock’s current market price, which is most easily found online. The annual dividend used in the calculation could be the total dividends paid during the most recent fiscal year, the total dividend paid over the past four quarters, or the most recent dividend multiplied by four. For stocks that do not pay a dividend, there is no yield. If growth and income is an investment objective, look for stocks currently delivering a yield that’s on par with the current market average. If you’re purchasing a stock for its dividend yield, it’s important to note how much of the issuing company’s earnings are being paid out to shareholders. While it’s not always the case, sometimes stocks that have the highest yield are being issued by a company that is trying to distract from its own financial setbacks. However, if the company isn’t able to rally, it could be forced to cut the dividend, decreasing the yield. This could also lead to a drop in share price.
When purchasing a bond issue at par, (i.e. at face value),the yield of a bond is the same as its interest rate. Typically, a bond with par value of $1,000 and an interest rate of 10% makes semi-annial payments of $50 each. For example, if you’re collecting $100 in interest on a $1,000 bond, the yield would be 10%.
Bonds purchased on the secondary market (after issue) generally produce a different yield from the stated interest (or coupon) rate because the price you pay differs from the par value. The current yield of a bond can fluctuate for a number of reasons, including market demand for bonds, the credit rating of the issuer, and the current interest rate environment.
Bank Deposit Products
Determining the yield of a savings account or CD is relatively straightforward – either your bank or your financial services firm can provide both an interest rate and an annual percentage yield (APY). These interest rates are often tied to the amount deposited and the amount of time the funds are held on deposit. For instance, CDs require a minimum term of deposit, and a penalty is generally imposed if funds are withdrawn before the agreed-upon term date. Like interest and yield information, bank policy regarding early withdrawals should be easily accessible.
Some General Tips
Whatever securities you may hold, there are a few practices you may find helpful overall when monitoring and measuring the performance of your investments.
While it seems basic, your account statement is a good place to start for a high-level look at performance. Your Account Summary will include account value, which will give you a good idea of how your account has performed since your last statement.
While easy to overlook, it’s important to factor in the transaction fees you paid when you purchased your investment to get an accurate measurement of your gains or losses. If you’re calculating the return on gains or losses after selling an investment, don’t forget to subtract the transaction fees paid when sold as well.
Taxes can affect the performance of your investments, so you’ll need to calculate after-tax returns to get the full picture. Once taxes are taken into account, you could find the gains you’ve made are not as significant as you initially thought. For this process, seeking out the help of a tax professional can be especially helpful.
Inflation essentially means that your money is losing value over time. For investments held over a long period of time, inflation can play a large part in determining your return. To calculate your return that takes inflation into account, you’ll need to find your real return:
- Real Return = Percentage Return – Inflation Rate
In order to draw accurate conclusions about the performance of your investments, it’s crucial that you understand your investment objectives and apply the right evaluation standards to each of your investments, depending on its role within your portfolio.