How to tell if your portfolio is a winner
It's important to know whether you should change your portfolio. Returns are relative, so use these markers to know if you have a winning portfolio.
The quality of portfolio returns, like many financial matters, is relative.
To get a rough idea of how their returns stack up, many investors measure their portfolio performance against a benchmark, such as the S&P 500 or the Dow Jones Industrial Average.
It’s not realistic to expect your portfolio to beat a benchmark, but it should keep pace with the overall market. Here’s how to tell if yours is on track.
Pick an appropriate benchmark
This is key, says Tim Shanahan, a certified financial planner and president of Compass Capital Corporation in Boston. “The typical default benchmark for many accounts and plans is the S&P 500, which may or may not be correlated to the assets that you actually own.”
If you have a well-diversified portfolio, you own not just stocks from U.S. companies of various sizes, but also international stocks, U.S. and international bonds, and alternative asset classes, such as real estate. You likely own most of these assets in the form of mutual funds, but you might also hold some individual stocks and bonds.
The S&P 500, meanwhile, reflects only the performance of 500 of the largest companies in the U.S.
An investment advisor can create a blended benchmark and compare it to your portfolio’s performance. A robo-advisor will probably provide a similar statement, often through an online tool that lets you track your portfolio against various benchmarks.
But if you’re on your own, you’ll have to do that legwork: Compare the large-cap equities in your portfolio to the S&P 500, but look at other indices, too, says Brent Dickerson, a certified financial planner with Trinity Wealth Management in Lubbock, Texas.
“I would suggest looking at the Russell 3000 index as a good broad index of large-, mid- and small-cap companies,” Dickerson says. “As for international stocks, assuming someone is invested in developed countries, they should consider the MSCI EAFE index as a good benchmark for that.” The MSCI EAFE covers equities in Europe, Australasia and the Far East.
Remember that index funds don’t need to be benchmarked
By nature, index funds and exchange-traded funds (ETFs) already track an index, whether that’s the S&P 500 or the Dow Jones. These funds own all of the investments within an index in an attempt to mimic its returns.
“If you hold an S&P 500 index ETF, then the benchmark is the S&P 500. So it’s basically comparing an apple with the same apple,” Dickerson says.
Managed mutual funds, on the other hand, employ professional investors to select and manage their investments, so they need to be benchmarked. The same goes for portfolios put together by financial advisors.
Don’t forget about fees
Investment fees are unavoidable: 401(k)s have administrative fees. Mutual funds, including index funds and ETFs, have expense ratios. If you work with an investment advisor or robo-advisor, you’ll be charged a management fee. And if you use part of your portfolio for stock trading, you’ll incur trade commissions. ETFs, which are traded like stocks, are also subject to trade commissions, though many brokers now offer a list of commission-free funds.
Fees reduce your returns. If yours add up to, say, 1%, you’ll pay $10 for every $1,000 you’ve invested. And if your portfolio is returning 7% on average, you’ll actually see a return of 6% after expenses. But these fees aren’t reflected in benchmarks.
“A benchmark is a raw thing,” Shanahan says. “Subtract fees to see the see raw return, and then compare that to the benchmark.”
Most mutual funds will show performance net of expense ratios, but you may have to subtract management fees, administrative fees and transaction costs yourself.
Don’t over-think it
Most account providers include a benchmark on your regular statements, and many provide comparison tools online, but you don’t need to compare your portfolio every week, month or even quarter. Once a year is fine, especially for retirement investors, Shanahan says.
But you should be paying attention to the markets on a regular basis, so you’re not surprised by what you find in your statements.
“There’s a risk of having too much headline news, but a lot of folks pay zero attention,” Shanahan says. “If the whole U.S. equity market is down for whatever reason, it’s logical that your account might be down, too.”
This article first appeared at NerdWallet.
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