Managing an investment portfolio is in many ways no different than managing a business. If you want to get the optimum return on your investment, you need to measure how well you are doing. If you run a business without measuring the growth in profits and assets and what has contributed to or detracted from that growth, then you won’t have sufficient information to know when or how things need to be changed in order to improve the return. Exactly the same principle applies to managing your investment portfolio.
If you are an investor rather than a speculator, your aim will be to optimise your return over a long time frame, say 5-10 years. Your investment time frame ends when you spend your capital, not at the point when you need income from your portfolio, so even if you are retired you will still be a long term investor for at least part of your portfolio. The total return on your portfolio is sum of the income received from the portfolio by way of interest, dividends or distributions, and the change in value of the portfolio which comes about from a change in the price of the investments you hold. This return should be measured on a quarterly basis. If your portfolio is partly invested in growth assets such as shares, then its value will move up and down over time – some years it will perform well and some years it will produce a negative return. A portfolio made up entirely of fixed interest investments should have a consistently positive return. However, risk and return go together and as an investor, your choice is between a stable portfolio producing a consistent but low return and a more volatile portfolio producing a variable return in the short term but a high return over the long term.
If your portfolio contains growth assets, don’t make the mistake of comparing the performance year by year with a fixed interest portfolio because to do so is to compare apples and oranges. There is one thing certain about a volatile portfolio – there will always be some years when a fixed interest portfolio would have done better. The problem is, we only know with the benefit of hindsight which years that is true for. For a growth portfolio, it is the average return over the period of investment that you should focus on, not the year-on-year return.
In the short term, the performance of each asset class in your portfolio should be compared against the market index relevant to that asset class. Your aim is to do better than the market. If your share portfolio dropped in value by 5% but the share market index went down by 15%, you did well with your shares. In the long term, your overall aim should be to produce a better average return after tax and fees than you would have achieved by leaving your money in the bank for the same period. With a well diversified portfolio, the more you have invested in growth assets and the longer your investment time frame, the higher your return is likely to be.
Liz Koh is a financial planner and the author of the best selling book – Your Money Personality: Unlock the Secret to a Rich and Happy Life, Awa Press, 2008, available from http://www.awapress.com.
For Liz’s best tips for financial security, visit her website http://www.moneymaxcoach.com to receive your free e-book “8 Steps to Financial Freedom”.