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How Do You Measure Investment Success?

I have conversations with people all the time about their investments.  Some are in formal meetings with clients or prospects but many are just casual discussions with friends, family or other acquaintances.  They know what I do so they often want to talk about what they are or are not doing with their investments. Some individuals brag about how their portfolio has done while others lament their lack of performance.  In either of these cases I try to ask the individual if they felt they were investing successfully.  For some reason, this is a difficult question to answer.

Investors often complain that their portfolio has been lagging the S&P 500, however, they fail to realize that if they have a balanced portfolio including a blend of bonds and equity then they should be lagging the S&P500 in up years. Others discuss how the handful of stocks they have chosen has far out-gained the market.  This may be the case while the market is humming along but they are comparing their returns to an index that has far less volatility. In either of these scenarios, they are not comparing apples to apples and don’t have a clear understanding of what investing successfully would look like for them.

So how should you measure investment success?   People often focus on the wrong metrics or variables when making this measurement.  Or even more often they haven’t thought about or discussed with their adviser what investment success really means to them. There are a few common ways that I see people measure this success:

  • Return Based: Put simply, how much has your portfolio returned?
  • Risk based: What kind of volatility has your portfolio displayed?
  • Benchmark Based: Has you portfolio performed better than benchmark X (S&P 500 is often the default in this case)?
  • Peer Based: Has your portfolio done better than your friends, colleagues or other investors?
  • Plan Based: Is your portfolio performing in line with your plan projections?

While I personally think some of these are more important than others the most important part in determining your investment success is establishing what measure is important to you in advance and making sure this measure is quantifiable.  Failure to do so can lead to difficulties when the time comes to thoughtfully assess how your investments are doing and decide if changes are necessary.  It is far too easy to look at your portfolio returns in hindsight and simply justify the performance as either good or bad.  However, it is important to understand that your portfolio could be up 30% in a year and still not be a success or it could be down 10% and it could be a complete success.

Simple steps to evaluating investment success:

  1. Choose a time period for the measure of success. Measurement and evaluation of investment results can vary greatly depending on the time frame you are using.
  2. Identify the method that you will use to evaluate success. See list above, or develop your own.
  3. Quantify what success means
  4. Identify any other outside variables that should also be considered (e.g. market conditions, etc)

While this process would seem very simplistic, we see it ignored over and over again. It can be applied universally, to someone just starting out or to Warren Buffett. Failure to follow these simple steps is also often the root cause for the failure of many advisory relationships. Success within the relationship is never clearly defined or communicated. This leads to many awkward conversations and can often poison the relationship.

Final Thoughts: As an investor, you should never just arbitrarily assess how well or poorly your portfolio (or adviser) is doing.  Failure to establish how you will measure this success in advance can lead to second guessing yourself or a false sense of security.  If these metrics are clearly laid out in advance, performing self-assessment and holding your adviser accountable becomes much easier.  You will avoid awkward conversations about your portfolio and will be in a better position to make changes if they are necessary.