As the markets become more volatile, more people are beginning to pay extra attention to their investment performance. It is human nature, even though not completely rational. When you perceive there is more likely to be loss, you want to avoid it. Nevertheless, thinking more about the potential losses only makes your heart sink. Before you act on your fear, remember your feelings have no influence on the market or your portfolio performance whatsoever.
But let’s say all the noise from the market makes you want to check how your portfolio is doing. Through my experience working with clients, I’ve found that a lot of people don’t know what data to look at, and how to explain the numbers they see.
In other words, it’s possible that you are looking at it the wrong way, and therefore coming up with wrong conclusions.
Here are some of the mistakes you might make when evaluating portfolio performance. Along with each mistake, I provide what I think is the more beneficial way to calculate and interpret your investment portfolio performance.
Ultimately, I believe tracking investment performance provides no value unless it’s in the context of helping you meet your life and financial goals. Keeping this in mind will allow you to understand my following rationale better.
So here we go.
4 mistakes you make when evaluating portfolio performance
Mistake #1: Look at your performance by account
When you first started working, it was easy to know your performance because you only had one account. The custodian was helpful, calculating the performance for you, even by different time periods. You were able to know exactly what your investment performance was.
But then as time went by, you made more money. You switched jobs. You got married. Suddenly you had multiple accounts under your name. It was difficult to tell at any given time how your overall portfolio was doing.
So as rookie investors, we made this same mistake. We begin to compare our accounts against each other! We start having thoughts like the following:
- Why does my old 401(k) perform better than the new one? I should have stayed in my old company!
- My Traditional IRA is performing better so I must move all my other accounts to this one!
- My RSU is doing much better than my 401(k). I should just invest all my money in my employer’s stocks!
However, all of these accounts have YOUR money! You are able to decide what you invest in in each account! (Caveat: sometimes you do have more restrictions within a 401(k).) Why are you pitting your accounts against each other?
The Right Way: Look at your portfolio performance holistically.
If you choose to keep track of investment performance, which I don’t think is necessary (see #4), make sure you look at your portfolio as a whole. Your multiple accounts do not all have to have the same asset allocation and investments. What’s important is that together they are invested in a way that meets your long-term goals, risk tolerance, and investment philosophy.
Sometimes it’s simply wiser to have your multiple accounts invested in different things. For example:
- It can be tax efficient to choose higher growth investments in a Roth IRA than in a Traditional IRA.
- Your 401(k) doesn’t provide all the funds you need to build the portfolio you want, so you use outside accounts to balance it out.
- If you tend to invest significant amounts in taxable accounts, you may wish to lower your annual tax burden by investing in low-dividend investments.
In these cases, you may deliberately have an “imbalanced” portfolio in each account due to tax treatments and restrictions. But in aggregate, your portfolio comprises the mix that you want.
In order to calculate investment performance properly this way, you need to use reporting software that will pull in information from all accounts. The information includes not just balances, but all the saving and trading data at different points of time. Don’t attempt to do it by hand!
If it sounds too cumbersome, I agree. Of course you may work with an advisor who includes comprehensive reporting as part of the service. (Comprehensive means not just the accounts they manage for you, but also all the “outside accounts”.) Or see #4 for what I think is the better way to track your financial progress.
Mistake #2: Look at performance excluding your spouse’s portfolio
Extending the same concept of #1, you should have a comprehensive view of your household’s portfolio, not just your own.
Through my years of practice, I’ve encountered couples coming to me and saying,
- My spouse’s 401(k) is doing better than mine. What can I do to beat it?
- My spouse contributes more in her retirement account while I take care of more expenses. Shouldn’t we make it equal?
- I don’t want to create a joint investment account because I want to contribute more than my spouse
If you and your spouse are planning as a unit for your joint future, then really there is no difference! You are not in a competition! You are working together toward common goals, so your portfolio is in fact just ONE!
(I understand that some married couples do not take this view and I respect that. However, I believe the longer your marriage lasts, the less likely you can avoid planning your investments together.)
The Right Way: Look at your portfolio performance as a household.
Against popular beliefs, you don’t really get to 100% protect yourself in the event of a breakup by keeping your accounts separate. Even when you don’t own accounts together, in a legal divorce you still should consider equitable distribution based on variables such as past income disparity, career lapse, tax treatments, and investment types, etc.
For instance, you don’t get to keep all of your retirement savings if your spouse had taken time off work to take care of your children. Also, if you own tax favorable accounts while your spouse doesn’t, don’t expect that you’ll automatically keep all the tax favorable balance.
Couples planning as a unit gives more flexibility on how to place the right investments in all the accounts. For example, if one spouse has limited options in her 401(k) and the other spouse participates in a better plan, you can optimize your contribution and investments if you consider your portfolio together.
Then of course, when you evaluate your performance, you can’t just look at your accounts. You should evaluate all of your accounts together, as a household.
Mistake #3: Look at performance in a short-time frame
As a modern day investor, we tend to get too much information on market performance. In every news report around the world, you’ll hear how much the Dow has lost or gained today, even though you shouldn’t make long-term investment decisions on a single day’s data.
Try to imagine, if your radio broke on the way home so you didn’t hear how the Dow fared today, does it make any difference in your life?
No? Now try to extend that timeframe. Let’s imagine that you were involved in a serious accident, and went into a coma for two years. You went under on January 1st 2008 and came back to life on the last day of 2010.
In the beginning of 2008, the market was just turning for a dive. In a year, the Dow would have lost half of its value. Luckily you missed all of it in your sleep. By the time you woke up, the Dow had returned close to its 2008 level.
The Right Way: Look at your portfolio performance with a long-term view.
When you are investing for the long-term, such as for your retirement, the short-term performance of your portfolio doesn’t tell you much. It doesn’t tell you whether you can retire. It doesn’t even tell you what kind of year you are going to have.
Even using annual performance is too short sighted in my opinion. In 2017, the Dow Jones Industrial Index grew by 25%. Do you really think the 25% annual growth will continue forever? No? Then why do you focus on that number? If the Dow ended with a 10% drop in 2018, doesn’t that mean overall it still grew by 15% in two years? What’s so bad about that?
You may ask, how long is long enough? When I look at the performance of a portfolio, I usually first go to the 10 year average. Inevitably, almost all portfolios have a positive 10-year average return. This is because in the long term, investment performance also reverts to the mean. Whatever ups and downs the market may have been through, eventually you are compensated for the risk you take in the viability and profitability of the companies. If there was no compensation for this risk, no one should invest in the market.
At the end of the day, I don’t really think looking at investment performance, even for a 10 year period, informs much about what you should do with your life or portfolio. This brings us to the last point.
Mistake #4: Look at investment performance, and not changes in net worth
Many people forget that their finances are comprised of more than just their investment portfolio. In the end, it’s your total net worth and income that you can spend. Focusing on investment return is like a game. You just want it to go up for the sake of it. But keeping track of your net worth will actually inform you whether you have the resources you need to live the life you want.
I do not report my client’s investment performance in my financial planning work for this reason. In my opinion, investment performance is a red herring. It’s the one thing we have the least control of, but we obsess over it.
The Right Way: Look at your net worth, not portfolio performance.
Even if your portfolio went down 10% this year, so what? Did you keep saving and investing when the market was low? Did you keep paying your mortgage so you save in your housing equity? Did you negotiate for that raise or a new job so that you can save more? Did you utilize the investment strategies that give you a tax advantage?
If the answers to all of the above questions are yes, then you are doing all you can, and the market will work its way to provide the return that is commensurate with the risks you take in the long-run.
In a year when the market was flat, all of my clients still had positive net worth growth. No one saw their net worth decrease, because all of them were still investing and paying down debt. And I’m confident that even in a market down year, the net worth is unlikely to drastically decrease with the market.
Net worth is the only statistic I report and track over time. My long-term clients have seen their net worth grew 20%, 50%, or even 100% year after year. It’s a more powerful number than any investment performance statistics you can think of.
Eventually all of our actions reflect back to our net worth. Whatever stage you are at, net worth is the best summary of all of your financial efforts. Even when you are laden with debt, seeing your net worth go from negative $100k to zero over the years makes a huge difference. If your investment account only has $100 in it, having a 100% investment return will only get you to $200. It barely moves the needle.
What other actions can accelerate your net worth growth?
- Pay down your mortgage faster or refinance at a favorable rate / term.
- Insure against catastrophic losses.
- Save more by controlling expenses or making higher income.
- Move to jurisdictions with a lower tax burden.
The list can go on and on. And note: all of these are within your control, and have nothing to do with your portfolio performance.
To recap, no matter how the market is performing, here’s what I think you should do if you are ever curious about how your portfolio is doing:
- Look at your portfolio performance holistically.
- Look at your portfolio performance as a household.
- Look at your portfolio performance with a long-term view.
- Look at your net worth, not portfolio performance.
Hope this helps!