Monitoring

Suppose that, last year, your portfolio generated a 12% return.  Was that good or bad?  Well, if you are comparing the performance of your portfolio to GIC’s, then the return was pretty good.  If you are comparing your return to an equity index that returned say, 20%, then the numbers don’t look so good.

The problem of course, is that most investors don’t have 100% of their portfolio in GICs, nor do they have 100% of their portfolio in stocks. Most have a combination of investments that include cash (treasury bills, bank accounts), fixed income (bonds) and stocks.

If we accept the position that most investors have a diversified portfolio, then we have to also accept that a 12% return tells us nothing about value. It’s like having a son who is seven feet tall. Is that good or bad? It’s good if he wants to play professional basketball. Not so good if he wants ready to wear clothes.

Knowing a quantity how tall, how much, your percent return, tells us nothing about value. Only by comparing a diversified portfolio against a passive portfolio benchmark, can you make an informed judgment about how well your portfolio did. If your passive benchmark returned 11%, and you returned 12%, then your portfolio did very well indeed.

A benchmark is simply an independent standard against which performance can be evaluated. Good benchmarks have five essential characteristics:
 

When we talk about asset mix, we are really talking about what percentage of the portfolio should be allocated to cash, what percentage to fixed income and what percentage to stocks. The asset mix is critical because it determines 85% to 90% of the total return of your portfolio.

Unfortunately, most investors spend too little time understanding asset mix. They buy a specific fund or a certain stock because of its past performance or its future potential. The asset mix is determined by default.

Typically investors fall into one of three basic categories; conservative, balanced and growth. You can argue, as some financial institutions do, that three categories are too generic. We would argue that each client deserves a personalized asset mix that can be accommodated by fine tuning the weightings within our three categories. Bottom line; asset mix is the priority, and for every client there is a appropriate personalized asset mix.

Accepting the position that there are three typical investor categories, each category has it’s own unique character. Conservative investors, for example, want a low risk income-producing portfolio. They lean toward investments that provide regular returns, even if these returns are low. Whereas others dream of wealth when they invest, conservative investors are motivated by the dread of poverty. Protection of principal is paramount.

We often find retired investors in this category. Either they are building a portfolio for estate planning purposes, or they are drawing an income to supplement their living standard. The generally accepted asset mix for a conservative income investor is; 20% cash, 50% fixed income and 30% equity.

Balanced investors pay attention to the income side of their portfolio, although generally it is not considered a critical supplement to their standard of living. At least not yet! Often the balanced investor will simply re-invest the portfolio’s income stream, effectively dollar cost averaging their investment program.

Balanced investors understand that financial security depends on some growth being attained within the portfolio and to that end, will spend a great deal of time understanding how much return is required to meet their long range objectives. They often set more reasonable goals that, for the most part, can be attained with their investment style. The generally accepted asset mix for a balanced investor is; 10% cash, 40% fixed income and 50% equity.

Growth investors are not at all concerned about income. Usually, they have a long time horizon and often, a sizeable net worth. The objective is to maximize the potential growth within the portfolio, taking reasonable risks.

Growth investors have an appreciation about the trade-off between risk and return, and are willing to assume higher levels of risk if it results in better performance. The generally accepted asset mix for growth investors is; 10% cash, 20% fixed income and 70% equity.

The REALWORLD Indexes provide the investor with a benchmark to compare how well their particular asset mix is performing. That’s important information. Because investors usually sit across the table from a financial advisor, and are keenly interested in knowing if the advice they are getting is adding value to their portfolio. The best way to know that, is to see how well the portfolio did against a reasonable benchmark.

What this means is that you can now answer the question; was a 12% return is good or bad? By having a benchmark, you have the answer.

To find our more about Croft Benchmarks please contact us directly.