By Ken Hawkins
– VP Research and Development Second Opinion Investor
Services Inc.
Opening my monthly investment statement, I wondered…
how is my portfolio really doing? I was interested in
knowing the absolute performance number because I know
I need to average about 6% per annum in order to reach
my financial goals. I was also interested in a relative
number – how was I doing compared to the stock
market index – would I be doing just as well if
I simply bought an Exchange Traded Fund?
Of course no matter how hard I looked, I couldn’t
find the one number I was looking for. No where to be
found was the rate of return my investments earned over
the last month, quarter, year, or last five years. Most
financial institutions just don’t want to show
clients how they’re doing compared to the appropriate
benchmark. When I first started investing 30 years ago,
that information was not available, and now in 2006
the performance information is still no where to be
found on my statements. For the last 10 years my company
has been saying this information is a priority but it
never appears.
Performance Measurement
Provides Important Feedback
Past and current performance statistics is vital information.
If an investor can't keep score of their actual return,
they can’t know if they're on track to achieving
their goals. With poor performance maybe the investor
should be spending less, or with better than expected
performance maybe he or she could be spending more –
or moving to a lower risk – lower return portfolio.
Also, without performance measurement how does one know
if adjustments should be made – let alone what
type of adjustments should be made to their investment
strategy?
Receiving proper feedback is important not only in achieving
ones financial goals but also in goals related to school,
employment, personal relationships, sports and almost
everything. If you wouldn’t drive a car without
headlights and a speedometer you shouldn’t invest
without measuring performance and comparing actual results
with a reasonable benchmark.
It is well established that providing proper feedback
on performance causes the performance to improve. Our
whole learning and education system is designed around
providing students with proper feedback on their performance
by using report cards and evaluations. In the workplace,
employee evaluations are an important process, providing
feedback to the employees with a goal to rewarding good
performance and to improve performance in the future.
In business the results of marketing or advertising
campaigns are measured against minimum acceptable standards
of performance. Strategies that don’t work (and
the managers who promote them) get shelved. It should
be the same with your investment strategies.
It is clear that the act of measuring performance can
by itself contribute to better future performance. According
to a study of over 3,000 people in weight loss and weight
maintenance programs conducted by researchers at the
University of Minnesota, daily weighing is an effective
strategy. Of those studied, 20 percent reported never
weighing themselves, while 40 percent said they weighed
themselves daily or weekly. Those who weighed in daily
lost 12 pounds on average versus an average of 6 pounds
for those who weighed themselves weekly; while those
who skipped the scale gained 4 pounds on average.
The daily weighing helps alert people that they're heading
into the "red zone" of gaining more than five
pounds. If someone notices early that they're on a weight
gain trend, they can take immediate steps to stop the
weight gain.
With investing the ‘daily’ weighing is replaced
with a monthly ‘weighing’ or measuring of
performance. How much (in percentage terms) did you
gain or lose, and how does this compare with the benchmark?
(See note below for a discussion of benchmarks)
In most aspects of our lives the regular measurement
of performance helps us to make the changes necessary
to improve performance. This is also true in investing
and with investing a small improvement, as little as
1% per annum, can often mean retiring one or two years
sooner.
Professional Investors
Know the Importance of Performance Measurement
In the world of the institutional investors, where professionals
manage hundreds of millions of dollars, performance
measurement is an important part of their ongoing investing
process. It would be unheard of for professional managers
to go to a meeting with their client and not have all
of the relevant performance benchmarks close at hand.
The performance numbers are crucial as they help shape
their investment policy and adjust their investment
strategies. They are critical because:
1. The rates of return
that their investments earned are used to determine
if they are on track to meet their long term goals.
2. The performance measurements
help determine which investment strategies worked or
did not work, and why they might not have worked. Adjustments
can be made to the strategies to correct problems that
might have existed and additional funds can be moved
to those strategies that were successful.
3. The performance numbers
are also important in making decision on the retaining,
hiring, and firing of investment managers. Those who
are able to consistently add value will be retained
and those managers who consistently do poorly will be
fired.
4. Performance numbers
are also an important part of an investment manager’s
compensation. Performance that exceeds the benchmark
is rewarded with bonuses, providing powerful incentives
to outperform.
Individual Investors
Can Benefit From Performance Measurement
For the individual investors, the same logic applies.
1. Performance numbers
provide essential feedback on the effectiveness of their
current investment strategy and the quality of the advice
they receive.
2. Monitoring the performance
and understanding the reasons behind it allow investors
to determine if they are on track to meet objectives.
3. Monitoring performance
against a benchmark may show if one’s assumptions
about risk and volatility are correct.
4. With proper performance
measurement, the investor can make adjustments to their
holding or strategies, retain or redeem mutual funds,
and to retain or fire their current advisers.
5. On the topic of firing
advisors, investors who manage their own money and consistently
under perform against a benchmark might want to reconsider
whether or not they need some professional advice.
Will providing performance statistics help individual
investor do better in the future? For those investors
who will ignore the numbers, more numbers are not going
to help. However, those investors who use the numbers
to gain understanding of how the performance was achieved,
and then use this information to make sensible adjustments
will benefit enormously by having performance statistics.
For more information, please visit
Second Opinion Investor Services.
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