2 Ways to Understand Your Portfolio’s Performance

investments photoYou just received your third quarter investment statement showing your portfolio’s performance. You have a loss for the quarter or year to date. Or perhaps you review your investment accounts online and some of them are showing a loss. And you think, the son of a gun financial planner didn’t say I’d have a loss…..

My advice is to stay the course. You don’t want to sell low and miss potential future gains. ut make sure that the loss you are seeing is a real loss in contrast to a cost-basis loss.  Both statistics are important but they measure your portfolio’s performance differently.

Investment Return Basics

Most investors should be keenly concerned about total portfolio return. Total return is made up of two pieces:

(1) changes in share price of the investment assets, and

(2) dividend or distributions from the investment asset.

Share price is easy to figure out. This is the statistic that gets reported in the press everyday.

The Dow Jones Industrial average is down 5.74% since the beginning of the year through September 30th. This statistic is calculated on the share prices of the 30 companies in the Dow Jones Industrial average.

You also can see it in the price per share of an individual mutual fund. For example, a share of the Vanguard Total Stock Market Index Fund (VTSMX) was $48.06/share on September 30th, down from $51.15/share on December 31, 2014.  There has been a loss of 6.04% for the first nine months of 2015.

The second piece of total return is the asset’s dividends or distributions. Most investors with retirement and/or brokerage accounts have their dividends and distributions automatically reinvested. For example, if the fund distributes $1/share, then the total distribution is used to buy more shares of the fund at the prevailing price.

These reinvested dividends are not incorporated into the statements above that relate solely to changes in the asset’s share price.

For example, the Vanguard Total Stock Market Index Fund has had three distributions so far in 2015. Most investors reinvested these cash dividends into more shares of the fund.  Thus if you held 10,000 shares in this fund at the beginning of the year, it would be misleading to say that the fund in your account lost 6.04% without taking into account that your total investment assets increased by the reinvested shares.

2 Ways to Calculate Return

The preferred way to calculate return is the total return approach which includes the two factors discussed above – share price changes and distributions. Often this return figure is prominently displayed when you log onto your accounts online. For example, Fidelity and Vanguard show this calculation front and center when you log into your accounts.  It is the preferred metric because it shows how your portfolio has performed overall, including reinvested dividends/distributions.

The second approach is a return figure using the fund’s cost basis. This approach adds the cost of each reinvested share to the asset’s basis.  Thus, the initial investment looks like it got bigger even though you did not actually write a check an put more of your cash into the asset.

The cost basis return figures are important for tax purposes. You pay taxes based on gains/losses calculated using your cost basis in the investment asset. So it’s not that this calculation is unimportant, it is just not a comprehensive indicator of the portfolio’s performance.

The other thing about the cost-basis approach is that, assuming distributions, cost-basis losses are larger than total return losses. And cost-basis gains are lower than total return gains. It is important to understand which performance calculation is displayed on your investment statements.

My advice is to make sure understand how your return is calculated – total return or cost-basis return – as you evaluate your portfolio’s performance.

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