Musings on Performance – Measurement (Part 3)

August 2, 2011 at 9:31 pm 1 comment

In this part of the performance series, I would like to address the question of performance measurement.  From the first glance, it might seem like a very simple question.  For example, if you started with $100K and ended with $110K, the performance was 10%.

The calculation is indeed very simple, but only in the case there were no cash flows in or out of your investment account.  In real life, however, these cash flows occur frequently, as we deposit or pull the funds from an account.  Some brokerage firms, such as e-trade, provide performance calculations on their clients’ portfolios.  But I would strongly advise to find out exactly how the performance is calculated — the final results could vary dramatically.

Here’s a very simple example.  You started with $100K portfolio, which stayed absolutely flat during the year.  You also deposited $20K during that year, ending with $120K.  So your performance should be zero (not 20%).  Does your broker or some other software you may be using give the correct answer?

Now, a more complicated example.  Again, you start with $100K portfolio, and deposit additional $100K during the year.  You end up with $220K.  What is your performance?  Answer – it depends.  If you deposited your funds at the very beginning of the year, you effectively started with $200K, so your performance is 10%.  However, if you put in the funds at the very end of the year, then the original $100K was responsible for the $20K gain, giving 20% result.  And if you made your deposit in the middle of the year, or in stages, the performance will be somewhere in between 10% and 20%.  Does your broker or your software handle this situation correctly?

So, make sure exactly how your performance is calculated before comparing it to others or to an index.  For my portfolio, I do the math myself.

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Musings on Performance – Don’t Forget Taxes (Part 2) Musings on Performance – Options Strategies (Part 4)

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Blog Author

Leon Shirman's long-term investment philosophy is summarized in his book, “42 Rules for Sensible Investing”, also available from Amazon.


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