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Lowell Herr
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Retired physics instructor and now editor of the ITA Wealth Management investment blog.
My company:
ITA Wealth Management
My blog:
ITA Wealth Management
  • My Portfolio Is Doing Great. Really? How Do You Know? 0 comments
    Jul 24, 2013 8:51 AM

    One comment I frequently hear when folks talk about investments is the following. "My portfolio is performing great." This statement conjures up questions I rarely ask as it tends to put the investor on the spot. Here are a few question that run through my mind.

    • Performing great with respect to what?
    • When was the portfolio launched?
    • Is the portfolio return calculated by an acceptable method?
    • Is there a benchmark for the portfolio and if so, what is it?
    • Is the benchmark appropriate for the portfolio?
    • What risk is involved and how is the risk measured?

    Nearly fifteen years ago I was involved in an interesting Internet discussion where the author of an investment book and associated software made the claim as follows. If one followed the advice of his software one could reach an annualized return of 15% per year. Rather a heady statement. One needs to recall this discussion began in the late 1990s when the U.S. Equities market was particularly hot.

    As an owner of this software I was interested in the claim and took up the challenge. I agreed to set up a portfolio of no trivial amount and I would precisely follow the signals of the software program for five years as the portfolio should double over that period. The bet was accepted. I figured I was a winner both ways. If the portfolio doubled, I could easily afford to pay off as a loser and if the portfolio did not meet the 15% annualized return, I would win the bet. As it turned out, I won the bet as the software program fell short of returning 15% per year, but the portfolio actually outperformed both the VTSMX and VFINX index funds, the two used as benchmarks for this portfolio.

    While I had several commercial programs available to track the Internal Rate of Return (NYSE:IRR) of the portfolio, none of these programs had the capability of tracking a benchmark such as the S&P 500 (MUTF:VFINX) or the total U.S. Equities market (MUTF:VTSMX). While one commercial program claimed to accurately track an index such as the VTSMX, I was able to show that the program did not correctly track cash flowing in and out of the portfolio. Two other commercial programs paid no attention to benchmarks. Tracking the performance of a portfolio without an acceptable benchmark is akin to high jumping without a bar.

    The discussion and debate over performance and doubling the portfolio in five years was taking place over the Internet and as a result a commercial portfolio tracking company took up the challenge to develop several benchmarks one could use to track portfolios. They got it right.

    In addition to the commercial company getting involved, a bright Excel programmer coded a spreadsheet that eventually evolved into the TLH Spreadsheet. This spreadsheet calculates both portfolio performance (tested for accuracy against three commercial programs), four benchmarks, and includes several portfolio risk calculations. One of the benchmarks (ITA Index) is customized to the strategic asset allocation plan for the portfolio.

    To understand what is meant by "my portfolio is doing great" one needs to consider a number of questions and it involves more than just avoiding loss of money, although that too is very important.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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