Portfolio Returns, How Am I Doing?

There is a major challenge in the investment industry relating to how you measure performance. Unfortunately there is no solution. So it becomes important you are awary of the issues when judging performance. Expecially because the fund managers marketing department will exploit them to give a good impresssion.

Absolute or Relative Returns

Comparing investments is often like comparing apples and oranges. If my portfolio is up 10% this year, is that good?

As an absolute measure 10% sounds good. However, if inflation is 12% then I am worse off in terms of purchasing power. Or if the market is up 20%, I would be under performing.

Instead I could compare it to an index. Then should I compare to the S&P500 which is up 15% or the FTSE100 which is down 11%. Obviously, I should choose the one most close to my shares, maybe a weighed average of both. Eventually, trying to match the index to my own mix of shares could end up constructing a index exactly the same as my portfolio.

Then again, I could be holding cash when the market goes down, so losing 5% when the market is down 10%, is beating the market but not a good investment.

Time Period

Another factor coming into play is timing. I could beat the market over a three year period but the market beats me the period is lengthened to 4 years. So which time period should I use. Clearly, the best period is since inception. What if I change my investment strategy, should I reset the inception date?

Also, the longer the period used the less importance the current year has on the average annual return.

Time weighted or value weighted returns

If I start with $1,000 and make 20% in year one and lose 20% in year two, what is my return? The time weighted return is 0% (+20-20). However, the value weighted return assumes profits are reinvested so $1,000 increases 20% to $1,200 then falls 20% to $960, a loss of 2% per annum.