Reader Question on How to Determine How Your Investments Are Doing

The following comment was left on this post from last week:

Have a question:

What reasonable standards should investors use to measure how well or poorly that they are doing?

I’m sure that an answer would include “it depends” but if so, depends on what?

We are about 10% under our 12.31.07 balances and we are pleased but how pleased should we be? There is always someone who well fare better or worse but I’m at a loss as to which reasonable “standards” that I should use to know how I’m doing?

That’s a very good question.

Unfortunately, the appropriate answer is: it depends.

From a general standpoint, your portfolio’s performance should be judged against the appropriate benchmark or benchmarks.

For instance, if you have a portfolio of 50% large-cap stocks and 50% bonds, you would not base your performance on solely on the S&P 500 Index. Rather, you’d base it on a 50/50 split between the S&P 500 Index and the appropriate bond index.

If your portfolio is comprised of large-cap, mid-cap, small-cap, bonds, and real-estate investment trusts, then you need to base the performance on benchmarks for all of those asset classes.

The reason for this is that it’s easy to say, “Wow! We did awesome last year. Our portfolio was up 8%!” The reality could be that a benchmark portfolio might have been up 12%, making your 8% return not so stellar.

Of course, another way to judge your performance is to do what BG suggested in the comments of that post and that is to base your performance on whether or not you’re meeting your future goals. It doesn’t matter how your portfolio is doing if it’s not helping you meet your future goals.

For example…

Let’s say you have a retirement goal of $1,000,000 (purely hypothetical, ignoring inflation). Your retirement is 20 years away and you have $100,000 saved up so far. You are contributing $500 per month into an S&P 500-based fund. You don’t expect your contribution amount to change (again, hypothetical).

Using the RATE function in Excel, I figured that the required rate of return to meet that goal is .78% per month (9.79% annualized). Given that the monthly geometric average total return on the S&P going all the way back to 1926 is .77% (9.64% annualized), you most likely will fall short of your goal by around $25,000.

This leaves you a few choices:

1. You can accept the lower amount at retirement.

2. You can take on more risk by moving into small cap stocks, which have a higher expected return but also are a lot more volatile (more on that in a future post).

3. You can increase your contributions. Based on my numbers, increasing the contribution amount to $540 per month, put’s the expected account value at a little over $1 million.

I realize that we are talking about math based on linear growth, which never happens in the real world. But, it can still be beneficial to have some sort of basis in reality. If your goal is $1 million and you’re investing a certain amount per month, it would be wise to know if you have a shot at meeting your goal.


4 thoughts on “Reader Question on How to Determine How Your Investments Are Doing”

  1. JLP-

    Could you post the =RATE() formula you used in the post? I tried playing around with it but couldn’t get it to work…seeing your sample will help.



  2. Ok, I’m all for hypotheticals & goals, but just a little dose of reality: IF your goal is $1 million, you have to keep in mind that your investments don’t stop growing even after you stop contributing. At least in my opinion you should not cash them out. Even if you moved 100% out of investments into a money market, you’re still going to earn interest. Most likely you will leave a portion invested, especially if you expect to live off your money 20+ years.

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