How are your investments doing?
Photo: Ryan McGuire. Source: Gratisography
On one level, this seems like a straightforward question: divide the portfolio ending balance by its beginning balance: that’s your return. But it gets more complicated. Did you add or subtract money? What are the tax implications? How did the rest of the market do? Above all, how much risk did the portfolio experience?
I get impatient when people discuss investment performance without considering risk. It makes a huge difference whether a 10% return was achieved in a gradual straight line, or whether the portfolio went up 25%, down 25%, then up another 17.5%. Both achieve the same result, but one road was a lot bumpier than the other.
Consider small-cap stocks:
Over the long haul it’s been shown that small companies return more than big ones. There are good reasons for this: it’s easier for small firms to grow, small companies can be more innovative; small firms get bought out—often at a premium. But small firms also fail at a faster rate than large companies. When you invest in a small company, there’s a greater chance that you can lose all your money. They’re riskier.
As a result, small-caps tend to be more volatile. They go up more, they go down more. Their long-term returns are higher, but investors pay for these returns via greater variability in their returns. If you have to sell during after a downturn, your return ends up lower—sometimes, much lower.
That’s why investors have to look at risk as well as return when they evaluate portfolio performance. Because return is what you get. Risk is what you pay to get it. And you don’t want to pay too much.
Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!