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How to "Read" Your Quarterly Reporting

by Liz G. Gillette

What does it mean when your portfolio is up 10%?

You receive portfolio performance reports every three months—a form of transparency that financial planning professionals introduced at a time when the typical brokerage statement was impossible to decipher. But it might surprise you to know that most professionals think there is actually little value to any quarterly performance information, other than to reassure you that you actually do own a diversified portfolio of investments. It's very difficult to know if you're staying abreast of the market, and for most of us, that's not really relevant anyway. Why?

The only way to know if your investments are "beating the market" is to compare their performance to "the market," which is not easy. You can compare your return to the Dow Jones Industrial Average, but that index represents only 30 stocks, all of them large companies. Most peoples' investment portfolios include a much larger variety of assets: U.S. stocks and bonds, foreign stocks and bonds, both including stocks of large companies (large cap), and smaller firms (small cap). There may be stocks from companies in emerging market countries like Sri Lanka and Mexico.  There may be real estate investments in the form of REITs and investment exposure to shifting commodities prices, like wheat, gold, oil, and pork bellies. 

To know for sure that your particular investments outperformed or underperformed “the market,” you would need to assemble a “benchmark” portfolio made up of index funds in each of these asset categories, in the exact mix that is in your own portfolio. Even if you could do that precisely, the daily, weekly, and monthly market movements would distort the original portfolio mix by causing some of your investments to gain value (and become larger pieces of the overall mix) and others to lose value (and become smaller pieces), and those movements could be different from the movements inside the benchmark. After a month, your portfolio would be less comparable to the benchmark you so painstakingly created.

Many professionals believe that there are several keys to evaluating portfolio performance in a meaningful way—and the result is very different from comparing your returns with the Dow's.

1. Take a long view. What your investments did last month or last quarter is purely the result of random movements in the market, what professionals call “white noise.” But you might be surprised to know that even one-year returns fall into the “white noise” category. It's better to look at your performance over five years or more; better still to evaluate through a full market cycle, from, say, the start of a bull market to the start of a new bull market. However, you should remember that there are no clear markers on the roadside that say: “This line marks the start of a new bull market.”

2. Confirm that you are on track to reach your goals. Your financial plan should indicate what mix of investments are required to help you reach your goals, such as a long, comfortable retirement. That investment mix may also contain bonds to reduce your risk and or generate “safer” income in retirement. That investment mix will not be comparable to any stock index. It is, however, designed to help you weather down as well as up markets, particularly if you need to take income from your portfolio. Lifetime Wealth establishes client portfolio allocations based on their clients’ unique risk tolerance and time horizons as well as their short- and long-term goals.

3. Recognize that some of your investments will go down even in strong bull markets. The concept of diversification means that some of your holdings will inevitably move in opposite directions, return-wise, from others. Ideally, the overall trend will be upward—the investments are participating in the growth of the global economy, but not at the same rate and with a variety of setbacks along the way. If you see some negative returns, understand that those are the investments you're counting on to give you positive returns if and when other parts of your investment mix are suddenly, probably unexpectedly, turning downward.

That doesn’t mean you shouldn’t look at your portfolio statement when it arrives.  Make sure the investments listed are what you expected them to be, and let your eye drift toward the longer time periods. Notice which investments rose the most and which were down, and you'll have an indication of the overall economic climate. And if your overall portfolio beat the Dow this quarter, or over longer periods of time, well, that probably only represents white noise.  

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