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My Return Beat the Market (or Not)

Ask your friends about their investment performance and stand by for a wide range of inflated guesstimates. Most people have only a vague idea of their returns, and when pressed, they’ll typically guess higher than the markets even though they can’t tell you how the markets performed.

It’s rare to find someone who actually knows their return, and it’s extremely rare to find someone who knows how their return compares to appropriate benchmarks. There would be far more index fund investors if people did have an easy way to obtain this information. That’s what happens to people who advance to this stage of investment understanding. Unfortunately, not many people do.

Unfortunately, calculating investment performance and selecting appropriate indexes for benchmarking is not as easy as it should be. Figuring out what’s in an investment product can be a chore, and trying to match that product to an appropriate benchmark can be close to impossible. This is why many people turn to an advisor.

That’s not always a good idea because advisors have a vested interest in making themselves look good. They tend to leave out important items from performance calculations — such as their fee — and often benchmark to inappropriate benchmarks that are easy to beat.

I worked with a high-producing Wall Street broker early in the 1990s. One of my jobs was to calculate quarterly investment performance for his clients. This was a humbling experience. Often the returns were so poor that the senior broker didn’t want his clients to know their results. He routinely pulled the reports out of the outbound mail. When his clients called, this advisor’s canned response was, “Everything is fine. Your account is doing really well! Let’s meet for lunch.” Obviously, this was before the Internet.

I wish I could say that performance monitoring is easy, but it isn’t.  To find your return, you have to factor out cash inflows and outflows, and then find indexes that represent different aspects of your portfolios and combine them properly. This will take time. And if you’ve done a good job, chances are very high you’ll become an index fund believer like I did in the 1990s.

There is a detailed explanation of a quarterly performance calculation in my free, self-published book, Serious Money, Straight Talk About Investing for Retirement. Go to Appendix 1 for the tutorial.  It’s as simple a methodology as I could make it. Also, read Chapter 2, Investor Results: Perception versus Reality. It’s an eye-opener about the gap between what people think they earned and what they actually earned. I wrote this book over a decade ago. The lessons are as fresh as yesterday.

Choosing proper indexes as benchmarks can be a more cumbersome experience. You’ll want to match your investment types and styles with index types and styles in a blended benchmark. PIMCO has a good tutorial on this subject; see Benchmarks: Selecting a Benchmark. There are also several online services to help monitor portfolios. Morningstar has a series of tools, including this tutorial.  Finally, here’s a 970-page book that really gets into performance calculation details, Investment Performance Measurement: Evaluating and Presenting Results, by Philip Lawton and Todd Jankowski, CFA Institute Investment Perspectives.

We become better investors when we calculate our performance and compare it to appropriate market indexes. It exposes investment gaps and helps us begin the process of recovery. The simplest way to close gaps is with a diversified portfolio of low-cost index funds and ETFs.