Last Updated on December 2, 2024
Overview – Knowing How Your Portfolio Is Doing
In any endeavour we pursue, whether it’s working towards a degree or trying to get into shape, it’s only natural that we occasionally ask ourselves how we’re currently doing. After all, how are we supposed to know if what we’re doing is bearing any fruit unless we stop and check? Doing something that isn’t producing desired results is just a waste of time.
Whether it’s test scores, pounds lost, or one of countless other metrics, we constantly measure our performance to make we’re on the right track to achieving our goals, and if not, understand what needs to be changed.
Investing is no different: in order to determine if they’re on track to achieving their goals and know if what they’re currently doing is working, investors must take the time to understand how their portfolios are doing. If that’s the case, how can portfolio performance be measured? This article will go over different ways as to how.
Why Stress Over Portfolio Performance in the First Place?
Before we go over some ways to assess how your portfolio is doing, there’s one question that probably comes to mind: why bother worrying about how your portfolio is doing in the first place? Given the effects of short-term volatility and other, non-controllable factors that can affect your portfolio, why go through the trouble of checking?
We previously discussed how an investor’s goals, strategies, and paradigms are closely interlinked: goals are where they want to go, strategies are how they plan to get there, and the paradigm they adhere to influences how those strategies are created and chosen.
While those things are certainly important to have, how can an investor possibly know if what they’re doing is actually working? By taking the time to assess their portfolio’s performance, of course.
Any strategy can sound good in theory, but you won’t know for certain if it works as intended until you check to see how it affects your portfolio. If your portfolio is in good shape, then keep pursuing your current set of strategies. If not, then it’s clear that adjustments need to be made. Coming up with dozens of elaborate strategies only to have them negatively impact your portfolio is nothing more than a massive waste of time.
Additionally, measuring portfolio performance is a way to ascertain if you’re on track to achieving certain goals or not. Wanting to pass your portfolio to your children to create generational wealth sounds great, but if your portfolio has consistently been declining over the past several years then perhaps this goal is in jeopardy. By knowing how your portfolio is currently doing, you can take the necessary action to correct its course before it’s too late.
Finally, knowing how your portfolio is currently doing helps establish a firm benchmark for future improvement. It’s easy to say “I want to improve my portfolio”, but improvement is always relative. Without a clear performance point of reference in mind, it’s impossible to know whether your efforts to turn your portfolio around are actually working or not.
So, regardless of what your reasons are, being familiar with how your portfolio is doing is an important piece of information most investors will need to be aware of.
Different Ways to Assess Portfolio Performance
Now that we know why it’s worth knowing how your portfolio is doing, we can now look at different ways to quantify its current performance.
Portfolio performance can usually be measured over a set period or as a “snapshot”, and metrics that report portfolio value, such as book value, adjusted cost base, and market value are commonly used when assessing performance.
So, without further ado, let’s go over what some of those methods are.
Percent Gain/Loss
By far one of the simplest methods of measuring performance, percent gain/loss is simply the percent difference between the market value and adjusted cost base. In equation form, this can be expressed as:
“Investment” is just a generic term used to describe anything that can experience a change in value. Whether it’s a stock, house, or portfolio, percent gain/loss can be applied.
In the context of our discussion, imagine you have a portfolio with a cost base of $1,000. A few months later, the market value of your portfolio increases to $1,500. Using the equation above, your percent gain would be 50%.
Conversely, if the market value of those shares dropped to $500, then your percent loss would be -50%.
Notice how time isn’t a variable in this equation. That’s because percent gain/loss is a “snapshot” measurement – it’s a value that can be measured at any point in time. If tomorrow the market value of your portfolio increased to $2,000 or $2,500, then the percent gain would change as well.
One of the biggest drawbacks to percent gain/loss is that it doesn’t make the measure over a period of time. Just because you have an impressive percent gain today doesn’t mean it will stay that way tomorrow.
Therefore, percent gain/loss can best be thought of as a “litmus test” – it can be used to get a rough idea of a portfolio’s health at a given time without much effort.
Trailing Return
A variant of percent gain/loss is trailing return. The major difference here is that this metric introduces a pseudo time variable by using the market value of a portfolio at a certain time in the past. In equation form, this is expressed as:
A common way to calculate trailing return is to make the measurement over a 12-month period.
Let’s say that on January 1 of this year, your portfolio had a market value of $5,000. Exactly 365 days ago, the market value was $3,500.
Using the equation above, the 12-month trailing return for your portfolio would be 42.86%. Put another way, over the past 12 months your portfolio had grown by 42.86%.
“Past market value” can be whatever an investor wants it to be, whether it’s a previous day, month, or even decade. An important thing to keep in mind is that, when comparing trailing returns, the past market values being used are consistent. Comparing a 12-month trailing return to a 1-week one isn’t exactly a fair comparison.
Compound Annual Growth Rate (CAGR)
The last portfolio performance metric we will be looking at is Compound Annual Growth Rate (CAGR). This metric has the following equation form:
The terms “end value” and “initial value” are used because CAGR is not used exclusively in investing. It can be used in any setting where percentage growth is desired, such as revenue growth.
Although CAGR seems complicated, it’s essentially just a measure of percentage growth year after year. Let’s clarify this by way of example.
Imagine your investment portfolio currently has a market value of $5,000. In 5 years time, your portfolio’s market value has increased to $10,000.
Plugging these numbers into the above equation, we get:
Solving this, the CAGR is 14.87%.
This means that every year your portfolio increased in value by 14.87%. As the name “Compound Annual Growth Rate” suggests, this 14.87% is a compound rate. Put another way, in the following year your portfolio value is approximately $5,743 (grew 14.87% relative to $5,000). The year after that, your portfolio will grow another 14.87%, but this time relative to $5,743.
Dividend/Interest Growth
The past three performance metrics we’ve looked at have focused primarily on a portfolio’s value. As important as a portfolio’s value is, it certainly isn’t the be-all-end-all when it comes to understanding performance.
Many investors are more concerned about the cash flow their portfolios generate, whether it’s from dividends, interest, or both. Therefore, another way some investors may want to measure portfolio performance is to assess how dividends/interest payments change over time.
Interestingly, all of the methods we discussed earlier can also be used to calculate portfolio performance in this way. Instead of using market value, we instead plug in dividend/interest numbers.
For example, imagine that last year you earned $1,000 in dividends, then the following year you earned $1,500. Using the percent gain/loss equation from earlier, this represents a 50% increase in dividends earned. Similar calculations can be done using the trailing return and CAGR formulas too.
How Often Should You Check Portfolio Performance?
Now that we understand the importance of knowing how your portfolio is doing, and have gone over some methods on how to measure its performance, this naturally leads us to yet another question: how often should an investor check in on their portfolios?
First, let’s look at the two extremes: checking too often, and not checking often enough.
Checking on your portfolio often may, at first, sound like a good idea. In practice, however, doing so may end up causing more harm than intended. That’s because investors who monitor their portfolios like a hawk could end up growing obsessed with its day-to-day activity. The slightest increase or decrease in performance could lead some investors to make some very irrational, emotionally-driven decisions, even if those fluctuations are simply the result of short-term volatility.
On the other hand, there are some investors who believe that investing is a 100% “passive” endeavour, and as a result, may only check on their portfolios once in a blue moon. At this other extreme, investors run the risk of losing lots of money because their portfolios may have badly deteriorated without them knowing. The current strategies they have in place may not be working as intended, and they may be wildly off the mark from achieving their goals, but they won’t know that since they hardly check their portfolios in the first place.
In that case, the logical solution would be to check once in a while. However, what classifies as “once in a while”? The answer, unsurprisingly, is: it depends.
For some investors, checking every couple of weeks is optimal, for some, it’s every month, while for others it may be every quarter. It really comes down to an investor’s comfort level, the size/complexity of their portfolio, and their experience.
What matters is that an investor is aware of how their portfolio is doing and has enough time to act on that information.
Wrapping Up
In any sort of endeavour a person pursues, chances are they will occasionally stop and check how they’re currently performing. If they’re performing well, then this is a good sign to stay the course. If not, then it’s clear that what they’re currently doing isn’t working and that something has to change.
In order for an investor to know if their strategies are working, if they’re on target to meet their goals, or to establish a benchmark for future improvement, they’ll need to know how their portfolios are performing. Fortunately, there are many ways to ascertain that.
Some investors choose to look at how their portfolios are doing every other week, while some may do so every few months. Regardless of how often an investor decides to check on their portfolio, what matters is that they’re aware of it when it matters and that they can use that information to act swiftly when needed.
