News of continued purchasing by the Federal Reserve further complicates what has been a difficult year to predict performance. A common question asked of portfolio managers is what is the return? This question applies to not only professional managers, which we gauge by their reported return on investment, but as individual investors we ask ourselves the same question. The problem is not the question - the problem is the framework for the answer.
Most brokerages express a portfolio as a time gated value as a percentage such as +3% YTD. Although this looks simple enough it excludes the most critical element of managing a portfolio for the long term. The correct question to ask is how is the portfolio is doing compared to doing nothing. In other words if you are not invested at all how much would your portfolio be worth compared to being invested. Comparing a portfolio to itself is a valuable data point but it does not fully represent performance. Comparing a portfolio to an index is even more fruitless since we are comparing one group of securities (the index) with our unique asset mix. It is nice to see if you are beating the index, or taking a beating, but it does not offer directional guidance to better mange your portfolio. In these feel good times of hitting high after high on the S&P 500 and Dow what does a percent gain really mean if you were not able to put any money (cash) in the bank. More importantly what would your total asset balance look like if you had converted everything to cash compared to your portfolio?
The stress of personally managing a portfolio can be reduced if you concentrate on asking a few fundamental questions then do the work to uncover and track performance.
- What is my total portfolio dividend sum in dollars and as a percent of the total portfolio?
- What monthly change was there in total market value?
- Is the total for the portfolio greater than if you were 100% cash?
The table below is a hypothetical conservative portfolio representing an allocation mix of 51% domestic stock, 3% foreign stock, 28% bonds and 17% cash. Your brokerage should be able to supply you with al the information in the table. If they do not have this level of data you will need to track changes manually on a monthly basis.
This methodology is far more directional and critical of a portfolio's performance than typical index comparisons. Collecting the data and drawing conclusions can lead you better decisions and perhaps mitigate some of the market noise.
Selling last May and not reentering the market would have been a disaster for the portfolio. Since last May $25,762 has been collected in dividends. The total market change was -$47,849, awful compared to the S&P 500 +12.74% but still better than all cash by a whopping $27,332. Yes, you are correct nearly all of the difference between being invested and cash came from dividends. Only $1,570 was added from price appreciation.
The colored area of the spreadsheet represents the variance as a percentage from fully invested to all cash. The more positive the value the greener the color, the more negative the color the more red it becomes. The definition for the invested balance is the starting balance plus the market change plus dividends and deposits, plus withdrawals. This accurately demonstrates the value of dividends. This model portfolio purposefully contains some January 2012 to April 2013 losers. Not every portfolio matches the markets performance, but consistent dividends can go along way to smoothing a portfolio's performance. If you were overweight stocks such as Appl e(AAPL), Molycorp (MCP), Facebook (FB) or GLD your portfolio might look somewhat like the model. The market being up does not translate to your portfolio being up. As a matter of fact if you are a religious dividend investor it actually works against your long-term gains since you are reinvesting dividends at high prices earning fewer shares.
Managing a portfolio requires fresh and critical thinking. If your portfolio is measured against 100% cash you will get a clearer picture of when or if you should convert to all cash. It's not possible to predict with a spreadsheet future market changes but you can use the new data set to compare individual holdings to the portfolio variance. If a stock is dragging down your total performance look carefully at it to ascertain what has changed. If performance for a security is below your portfolio variance for a month put a close watch on it. This model reflects what volatility translates to in asset value month to month. If a holding is significantly above your variance consider covered calls to add profitability to a winning position. If a stock dividend yield is below your portfolio average look for other stocks in the same sector to maintain your target asset allocation, stocks that have higher yields or artificially boost your yield by using covered calls. You will collect a premium and if your strike price is reached sell the stock that no longer meets your portfolio's dividend criteria.
Sell in May and go away? Not if you want to increase your portfolio's value. Even if you didn't pick all winners.