Measure Your Portfolio with the Right Yardstick

01/24/2011 4:28 pm EST


Rob Carrick

Columnist, The Globe and Mail

Now’s the perfect time to do a comprehensive review of your portfolio, says Rob Carrick, columnist for The Globe and Mail.

Investors say the darndest things.

Like the woman who claimed her adviser had done well for her over the longer term, but was letting her down in the current year because her portfolio was off 3%. As mutual fund executive Tom Bradley recalls that conversation with a prospective client a few years ago, the reality was that the woman’s portfolio had underperformed over the past five years while producing comparatively good short-term numbers.

Many times over the years, Mr. Bradley has come across badly informed people making erroneous pronouncements about their investments. And so, he’s written a guide for investors called How Is My Portfolio Doing … And What Should I Do About It? (Read it here.)

“The level of understanding on how people are doing is abysmally low,” said Mr. Bradley, president of Steadyhand Investment Funds. “I just got sick of hearing [complaints] when I knew darn well the person was off base.”

The investment industry deserves a lot of the blame for this situation, a point Mr. Bradley does not dispute. He says there’s too much emphasis on marketing and keeping clients, and too little personalized return information provided in client account statements.

But investors themselves have to take some responsibility for monitoring their returns. Year-end account statements should be rolling in, so now’s an ideal time to get started with the comprehensive annual review suggested by Mr. Bradley.

“I want you to do this once per year, but do it thoroughly,” he said. “If you try to do it every quarter or even semi-annually, you’ll cut corners.”

Reviewing on an annual basis also addresses what Mr. Bradley describes in his guide as a tendency for people to monitor their portfolios too frequently and thus make themselves vulnerable to bad news.

He quotes Nassim Taleb, author of the influential book The Black Swan, as saying that people beat themselves up about bad news two to two and a half times more than they celebrate good news. And he cites data from the investment analysis firm Morningstar showing the S&P/TSX composite index has been up 74% of the time over one-year periods, but up only 54% of the time on a daily basis.

Investment statements are often issued every three months, but Mr. Bradley says quarterly performance data is irrelevant. “Quarters add up to be years, but we try to make the point that there’s virtually no useful information in how you’re doing in quarterly returns.”

For a couple of reasons, Mr. Bradley’s preference is the five-year view. Five-year data is readily available online, and the period is long enough for money managers with distinctive styles to strut their stuff.

Now for your numbers. Grab a copy of your account statement and find the annualized five-year performance numbers. What, they’re nowhere to be found? The sad reality in Canada’s investment industry is that this level of information is not commonly offered.

Dalbar, a financial services market research firm, has found that overall rate of return is one of the top five most important statement elements that investors look for on their statements. And yet, “the majority of segments in the financial services industry are performing poorly in this category,” Anita Lo, vice-president at Dalbar’s Canadian division, said in an e-mail.

Mr. Bradley has found an online calculator from a financial advice firm called Weigh House Investor Services that can help investors find their personal rates of return ( Just type in the start and end values for your account and your contributions and withdrawals along the way; at the end you’ll get an average annual rate of return.

Now, by themselves, performance numbers mean little. Only when you have the correct context can you properly assess how you’re doing.

Mr. Bradley’s suggestion is to create what he calls a default portfolio, against which you can measure your own holdings. Start by noting the percentage of your portfolio in five key asset groups: Cash, bonds, Canadian stocks, US stocks, and international stocks. Then, find the correct benchmark indexes for each of these assets and build your default portfolio by adding them in the same proportion they hold in your portfolio.

If you have 40% in bonds, then 40% of your default portfolio will be represented by the DEX Universe Bond Index (see chart for other benchmarks). If the index made 5% in a year, then it contributes 2% to your default portfolio return. That’s the 5% index return multiplied by the 40% weighting bonds have in your portfolio.
Ideally, you’ll have returns over the past five years and longer that beat the benchmark. Underperformance by a percentage point or two in the past year or three years is not cause for major changes.

Three key points for further assessing your portfolio from Mr. Bradley:
  • Losing money in a year is part of life as an investor, even if you have a diversified portfolio: “Good returns over the long term will come with some periods of negative returns.”

  • Healthy portfolios may have holdings that are money losers over a year or longer: “If you feel comfortable about everything that you own, you’re not diversified.”

  • Weak returns do not necessarily mean changes are needed: “Just because bonds, for example, didn’t do much for my portfolio this year doesn’t mean they’re not playing a useful role.”

The final part of your portfolio checkup is an audit of the fees you’re paying. Mr. Bradley describes fees as a “guaranteed lost return,” which reflects the fact that the costs of investing reduce your gains. Still, he thinks fees have to be assessed in terms of the value they bring to your portfolio.

Among the fees to consider are stock-trading commissions, mutual fund management expense ratios, and sales charges at the time of purchase, annual administration fees (pay particular attention to registered accounts here) and advice fees paid to advisers in fee-based accounts.

Mr. Bradley said the past decade was a tough one for investors, with two stock market crashes and dismal performance from US and global content. Discouraging news from your annual portfolio checkup isn’t a done deal, however.

“The Canadian stock market and the bond market have made 6% or so over the last decade,” Mr. Bradley said. “If you look at your portfolio, you’ve probably compounded at a rate of 4.5 or 5%.”

Working with Benchmarks

Here are the key benchmarks for assessing your portfolio, along with their returns over the past ten years:

Click to Enlarge

To accurately measure your portfolio returns, compare them against those of a default portfolio built using the above benchmarks. Include each in the same proportion as it represents in your portfolio. Here are some simple examples that use different mixes of stocks and bonds:

Click to Enlarge

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