Measuring Your Portfolio's Performance

September 2, 2009

Once you've implemented and rebalanced your portfolio, understanding how to measure its financial health and viability is key to long-term money-management success.

Now that you have designed, implemented and rebalanced your portfolio, you need to determine if your strategy and management efforts have been successful. The only way to do that is by measuring your portfolio’s performance. In this blog, I’ll walk you through how to do that effectively, but first I’d like to emphasize why measuring performance is such an important practice.

The first is that we live in a dynamic world. Your life changes, the market environment changes, your risk tolerance changes. The terrific attribute of investing is that you always have options, which you can change at any time. But you won’t know which ones to change without measurement. For example, perhaps you find that some of your more risky investments are producing the same returns as your safe cash investments. In that case, why take the additional risk by continuing to hold that risky investment for the same return as cash?

The second is that the allocation of your portfolio will change over time. Be sure to measure the variances in your asset allocation so you can accurately rebalance your portfolio on a regular basis.

Finally, mistakes happen. Perhaps you meant to trade one fund and traded another. If you don’t check periodically on your portfolio activity, you could miss a critical error.

So, be sure to measure your portfolio on a regular basis by following these four steps:

1. Review the activity in your portfolio from your last measurement period. You should reconcile your trades and account values with what your custodian is reporting to you.

2. See how your current allocation compared to your targets. If you have rebalanced correctly, your actual and target allocations should be reasonably close.

3. Calculate the return of your portfolio net of all expenses. It’s what you keep that matters.

4. Evaluate the risk of your portfolio.

Use benchmarks for the last two steps so you know how you’re performing and how much risk you’re taking versus some well-known industry benchmarks. There are some free resources on the Web that can help you. Go to any of the big search engines to find total return information for major indexes like the S&P 500 for domestic stocks, Barclays Aggregate Bond Index for bonds, and the Europe Australasia and Far East (EAFE) Index for international stocks. For cash benchmarking, look at rates on money market accounts or CDs. Your return should be somewhere between the high but risky returns of aggressive stocks and the low but stable returns of cash.

The simplest way to measure is to keep all of your data in a spreadsheet. It should contain your target allocation so you have a basis for comparison. You should format it so that by entering information regarding the value of your portfolio and your periodic contributions and withdrawals, the return of your portfolio is calculated for you. If you are proficient with Excel, there is a formula function that will assist you in creating this type of spreadsheet. If not, break out your trusty calculator and do your math the old fashioned way. It may be a bit cumbersome, but in time, your portfolio will thank you for it, and you will thank yourself for doing it.