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The Keys to Understanding Investment Performance

Ignore the headlines, think global, and crunch these three often-overlooked numbers.

By Mindy Yu, CIMA®

Director of Investing, Betterment |

Published Mar. 30, 2022 | Updated Aug. 29, 2022

The Keys to Understanding Investment Performance Aug 29, 2022 12:00:00 AM Ignore the headlines, think global, and crunch these three often-overlooked numbers. Regardless of how long you’ve been in the market, at some point you’ll likely want to know how your portfolio is doing and whether you’re on track to reach your goals. Or in another scenario, you may be shopping around for investment managers and comparing their portfolios. In this guide, we’ll help you think through either situation and share our philosophy on performance along the way. How to evaluate your investment performance Investors want to make wise financial decisions, and those decisions, for better or worse, tend to be influenced by media coverage of the market. So before we share some ways to more accurately crunch performance numbers, here’s a heads up on two common fallacies that might be skewing your perspective: The Dow Fallacy Benchmarks like the Dow Jones Industrial Average are popular, but they don’t actually tell you much about the stock market. The Dow only represents 30 US stocks. And even larger benchmarks like the S&P 500 don’t give you a full picture of the US market—let alone the global market. We’ll share a more comprehensive benchmark below. The Points Fallacy It’s common to hear reporters and investors talk about how many points a benchmark has dropped. Headlines like “Dow loses 500 points” sound pretty unsettling. But points alone don’t tell you much. It’s far more valuable to look at the percentage. If the Dow is at 35,000 points, a 500 point drop is less than 2 percent. That’s not something long-term investors generally need to worry about. With those out of the way, how do you actually get a clearer picture of an investment’s performance? Unfortunately, you can’t just look at your earnings. Accurately measuring your progress means adjusting for three crucial variables: Dividends, aka the earnings companies share with stockholders Inflation Taxes Reinvested dividends can make a big impact over time, so make sure you’re taking those into account. The Federal Reserve publishes inflation data, so you can adjust your total returns based on annual inflation. And taxes vary by individual and account type. All these factors make a big difference when it comes to measuring performance. If you want to know how you’re performing relative to the market, that begs the question, “Which market?” Many of our portfolios are globally-diversified. In that case, your best bet is to benchmark against the MSCI All Country World Index. It’s a much better representation of how the entire market is doing. How Betterment simplifies performance Manually crunching the numbers in your portfolio/s can be a hassle. As a Betterment customer, we simplify the process by showing you: The sum of the parts. We pull together all the accounts inside a specific goal and show their performance as one number. Zooming in to the account level, we also summarize the value of the portfolio itself. Your total returns. These include price changes and dividends together, instead of breaking them out separately. Changes in the prices of assets in your portfolio are more volatile than total returns and don’t show the overall picture. The big picture. We show your performance over as long a period as possible to help keep you focused on the long-term and minimize short-term stress. We don’t encourage frequent monitoring of performance, but if you do want to review performance, you have the tools necessary to do so. Two of those tools are time-weighted return (TWR) and individual rate of return (IRR). Time-Weighted Return When you invest, you often do it a little bit at a time. A contribution here, a contribution there – or even better, contributions made on a consistent schedule via auto-deposit. The time-weighted return imagines that all the contributions you’ve made to date happened all at once on Day 1. This way of crunching returns takes deposits and withdrawals out of the equation when evaluating your portfolio performance. Why would you want to do this? Because cash coming in and out of your portfolio at different times can distort and complicate your returns due to the nature of the constantly-fluctuating stock market. Also, if you were comparing returns across two different accounts with two different cash flow patterns, you couldn’t be sure if the difference was due to the investments or due to the timing of the cash flows. The time-weighted return can refer to a price-only return, or a total return. Price return reflects only the change in price of the asset, while total return reflects both price and reinvested income. By default, Betterment displays total return for a more comprehensive view of performance. Individual Rate of Return The individual rate of return, on the other hand, is affected by each and every instance of cash flow that goes in and out of your portfolio. Cash flows at Betterment can include deposits, withdrawals, dividends, and fees. IRR does a better job of answering the question, “What are the average returns on the dollars I personally deposited into Betterment?” as opposed to “How well does Betterment design and manage the portfolios I have with them?” Look beyond performance when sizing up investment managers Make no mistake, the construction and performance of a portfolio is important, but it’s not the only thing you should consider when sizing up the services of an investment manager. We recommend a more comprehensive set of criteria: Monetary costs such as commissions, trade fees, and assets under management (AUM) fees. These can create a drag on your returns. Non-money costs like the amount of time and effort required of you. Does a service come with a high time or stress cost for you to get the most out of it? Investing philosophy and whether it aligns with your values. Some funds, for example, try to deviate from an index and may cost more as a result. Tax efficiencies such as tax loss harvesting and asset location. Your stated returns likely won’t take into account any potential value these tools may have added. When choosing an investment manager, the key isn’t to focus solely on investment performance; it’s to focus on service, fit, and investor returns.

Regardless of how long you’ve been in the market, at some point you’ll likely want to know how your portfolio is doing and whether you’re on track to reach your goals. Or in another scenario, you may be shopping around for investment managers and comparing their portfolios. In this guide, we’ll help you think through either situation and share our philosophy on performance along the way.

How to evaluate your investment performance

Investors want to make wise financial decisions, and those decisions, for better or worse, tend to be influenced by media coverage of the market. So before we share some ways to more accurately crunch performance numbers, here’s a heads up on two common fallacies that might be skewing your perspective:

The Dow Fallacy

Benchmarks like the Dow Jones Industrial Average are popular, but they don’t actually tell you much about the stock market. The Dow only represents 30 US stocks. And even larger benchmarks like the S&P 500 don’t give you a full picture of the US market—let alone the global market. We’ll share a more comprehensive benchmark below.

The Points Fallacy

It’s common to hear reporters and investors talk about how many points a benchmark has dropped. Headlines like “Dow loses 500 points” sound pretty unsettling. But points alone don’t tell you much. It’s far more valuable to look at the percentage. If the Dow is at 35,000 points, a 500 point drop is less than 2 percent. That’s not something long-term investors generally need to worry about.

With those out of the way, how do you actually get a clearer picture of an investment’s performance? Unfortunately, you can’t just look at your earnings. Accurately measuring your progress means adjusting for three crucial variables:

Dividends, aka the earnings companies share with stockholders
Inflation
Taxes

Reinvested dividends can make a big impact over time, so make sure you’re taking those into account. The Federal Reserve publishes inflation data, so you can adjust your total returns based on annual inflation. And taxes vary by individual and account type. All these factors make a big difference when it comes to measuring performance.

If you want to know how you’re performing relative to the market, that begs the question, “Which market?” Many of our portfolios are globally-diversified. In that case, your best bet is to benchmark against the MSCI All Country World Index. It’s a much better representation of how the entire market is doing.

How Betterment simplifies performance

Manually crunching the numbers in your portfolio/s can be a hassle. As a Betterment customer, we simplify the process by showing you:

The sum of the parts. We pull together all the accounts inside a specific goal and show their performance as one number. Zooming in to the account level, we also summarize the value of the portfolio itself.
Your total returns. These include price changes and dividends together, instead of breaking them out separately. Changes in the prices of assets in your portfolio are more volatile than total returns and don’t show the overall picture.
The big picture. We show your performance over as long a period as possible to help keep you focused on the long-term and minimize short-term stress.

We don’t encourage frequent monitoring of performance, but if you do want to review performance, you have the tools necessary to do so. Two of those tools are time-weighted return (TWR) and individual rate of return (IRR).

Time-Weighted Return

When you invest, you often do it a little bit at a time. A contribution here, a contribution there – or even better, contributions made on a consistent schedule via auto-deposit.

The time-weighted return imagines that all the contributions you’ve made to date happened all at once on Day 1. This way of crunching returns takes deposits and withdrawals out of the equation when evaluating your portfolio performance.

Why would you want to do this? Because cash coming in and out of your portfolio at different times can distort and complicate your returns due to the nature of the constantly-fluctuating stock market.

Also, if you were comparing returns across two different accounts with two different cash flow patterns, you couldn’t be sure if the difference was due to the investments or due to the timing of the cash flows.

The time-weighted return can refer to a price-only return, or a total return. Price return reflects only the change in price of the asset, while total return reflects both price and reinvested income. By default, Betterment displays total return for a more comprehensive view of performance.

Individual Rate of Return

The individual rate of return, on the other hand, is affected by each and every instance of cash flow that goes in and out of your portfolio. Cash flows at Betterment can include deposits, withdrawals, dividends, and fees. IRR does a better job of answering the question, “What are the average returns on the dollars I personally deposited into Betterment?” as opposed to “How well does Betterment design and manage the portfolios I have with them?”

Look beyond performance when sizing up investment managers

Make no mistake, the construction and performance of a portfolio is important, but it’s not the only thing you should consider when sizing up the services of an investment manager. We recommend a more comprehensive set of criteria:

Monetary costs such as commissions, trade fees, and assets under management (AUM) fees. These can create a drag on your returns.
Non-money costs like the amount of time and effort required of you. Does a service come with a high time or stress cost for you to get the most out of it?
Investing philosophy and whether it aligns with your values. Some funds, for example, try to deviate from an index and may cost more as a result.
Tax efficiencies such as tax loss harvesting and asset location. Your stated returns likely won’t take into account any potential value these tools may have added.

When choosing an investment manager, the key isn’t to focus solely on investment performance; it’s to focus on service, fit, and investor returns.

Track progress toward your goals with Betterment

With Betterment, tracking your progress is simple. Your account dashboard is organized around your goals. For every goal, we’ll show you your progress and estimate the likelihood that you’ll reach it with your current approach.