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Evaluating Returns Requires Investment-Performance Perspective

When you want to evaluate your investment returns, what do you compare them to? Do you compare your returns to those of friends and neighbors, or maybe to random market indexes?
If you do, you might be losing your performance perspective. To fairly evaluate your investment manager or a portfolio of investments, you and your financial adviser should determine how well they have performed in relation to:

  • Your specific goals and objectives;

  • The general market environment and the specific market environment for the asset classes in which you are invested;

  • The performance of other managers/investments with similar investment objectives;

  • The amount of risk taken to achieve your return.

Your goals and objectives

For many investors, the most important indicator of success is how well they meet their long-term goals. After all, what good is it if your portfolio’s return beats an arbitrary benchmark but is not in line with your long-term investment needs and tolerance for risk?

Whether saving for retirement or for a child’s college education, the first step toward reaching your goals is to develop a financial plan against which your progress can be measured.
The stock market advanced more than 33 percent in 1997, as measured by the Standard & Poor’s 500 (S&P 500) Index, but not all stocks equally participated. Large company stocks, which have a greater impact on the S & P 500 than small stocks in the index, outperformed small company stocks in three of four quarters in 1997.

If your portfolio consisted of mostly smaller company stocks, the S & P 500 wouldn’t have been a good benchmark in evaluating your portfolio’s performance.

Investment styles, such as growth or value, are cyclical in nature and can outperform each other at different stages of market cycle. In 1997, growth stocks generally outperformed their value-oriented counterparts.

In addition, U.S. stocks generally outperformed international stocks. There are many subcategories of these general investment styles that also should be considered. Therefore, one would not expect a small company, growth-oriented manager to perform in line with a large company, value-oriented manager.

Risks versus return

In the financial industry, we generally define risk in terms of volatility of a portfolio’s returns over time. This is because the volatility of an investment’s returns will affect an investor’s ability to achieve his long-term financial goals. Historically, investors have been rewarded with higher long-term returns in exchange for assuming greater investment risk.
Conversely, less risky investments tend to provide a more predictable but lower rate of return. Most investors fall somewhere in between, holding a blend of the various asset classes as they seek to participate in up markets while minimizing losses in down markets.

The allocation of your assets will influence your investment returns.  So, keeping track of investment performance is critical in any successful financial plan. However, with so many variables to consider, investors often lose their long-term perspective and focus on one thing – short-term return. Losing the performance perspective can lead to misinformed investment decisions that make it more difficult to achieve long-term goals.
For more information on how you can keep your performance perspective, contact your financial adviser today.

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Information is provided for review and consideration only. Please consult legal and tax advisors for practical advice pertaining to your business and personal situations.

This page was last reviewed and/or updated on Friday, March 12, 2010 05:10 PM

 
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