Standards for Evaluating Portfolio Performance are critical. Even if you don’t want to be a portfolio manager yourself, it’s important to understand the standards for evaluating portfolio performance so you can hold your financial advisor or stock broker accountable. That’s why…
In this short blog post you’ll learn some of the most common standards for evaluating portfolio performance. And don’t worry:
While there’re a couple of different ways you can evaluate the performance of your stock portfolio they are all simple to grasp. So let’s dive into the most common standards for evaluating portfolio performance…
Absolute Standards for Evaluating Portfolio Performance:
The most basic standard for evaluating portfolio performance is absolute returns. And this performance measurement is also the easiest to use. Absolute portfolio performance just means “the percentage value that your stock portfolio went up or down.” It is your percentage return on the money in your brokerage or investment account. That’s simple enough, right?
And by the way, you can measure your absolute portfolio performance over a period of years, months or even weeks (depending on your investment timeline). To calculate the absolute performance of your equity portfolio simply subtract your current account balance from your starting account balance and divide by your starting account balance. So if you have 100K in your account and now you have 110K after a year of trading, you would just do (110K-100K)/100K = 10% absolute return this year… Make sense? Good.
But wait! Although the absolute return is easy to calculate, it doesn’t always give you the full picture in terms of evaluating portfolio performance. Which brings us to the next common method to evaluate portfolio performance…
Relative Standards for Evaluating Portfolio Performance:
Another common standard for evaluating portfolio performance is relative return. While relative return requires an extra step of calculation, it gives you a much more in-depth method to evaluate portfolio performance. So how do relative returns work when you’re evaluating your portfolio performance?
Basically, you evaluate your portfolio’s absolute performance and then compare it to the absolute performance of an appropriate benchmark, over the same time period. The most common benchmark is the S&P-500. So basically you are just saying “how did I do relative to an index of stocks?” Subtract your absolute return from the benchmark index to get the relative return.
If your relative return is negative then your portfolio is under-performing. And conversely if your relative return is positive then you are outperforming the benchmark. So with that in mind hopefully you can see that relative returns are a great standard for evaluating portfolio performance.
But there’s one other standard for evaluating portfolio performance that’s worth mentioning…
Risk-Adjusted Standards For Evaluating Portfolio Performance:
One other standard for evaluating portfolio performance is Risk Adjusted Return on Capital (RAROC). This method of evaluating portfolio performance gives you a look at your return relative to the risk you took to get that return. This standard for evaluating portfolio performance is therefore of high interest to conservative investors. So how do you calculate your risk adjusted return on capital to evaluate your portfolio performance?
The easiest way to account for risk when evaluating your portfolio performance is using the Sharpe Ratio. The ex-post Sharpe Ratio gives an indication of how the investor is compensated for the amount of risk taken to realize portfolio returns. Basically you take the realized return of your risky asset, subtract the realized risk free-rate of return (e.g. short dated US T-Bill) and divide by the standard deviation of the risky asset. Voila!
That’s how you get a risk-adjusted standard for evaluating portfolio performance. And if you think Sharpe Ratio might be the best standard for evaluating your portfolio performance I recommend you read this article explaining how to use the Sharpe Ratio in detail. The Sharpe Ratio is easy to calculate. But it’s worth running through a few examples in order to get comfortable with this risk adjusted standard for evaluating portfolio performance.
What’s Your Favourite Standard For Evaluating Portfolio Performance?
So there you have it! And now that you are familiar with the common standards for evaluating portfolio performance, you can be aware of the best ways to measure the performance of your own portfolio.
You’ll also be aware of how other people use these performance standards to present their own returns – so you won’t be deceived by sneaking portfolio managers looking to drum up assets under management. Sound good?
And Hey: If you’re looking for more information on how to get superior portfolio performance I encourage you to sign up using the form below. You’ll get exclusive e-mail only stock ideas and investment analysis on the regular. So what are you waiting for? Sign up below…