When someone says, “My portfolio returned 15% last year!” or “My portfolio has consistently averaged 15% per year,” we might be impressed. But what does it really mean? Over what exact period? Calendar year, year to date, or the year up to yesterday? What does consistently mean? Did your portfolio return 15% every single year? If so, there’s a good chance you may be invested in a scam.
Measuring portfolio returns is an entire field of study. Calculating long-term portfolio return is far more complex than a quick ‘back-of-the-matchbox’ exercise. It becomes especially tricky when there are big contributions or withdrawals from the portfolio. Even experts can argue vehemently over the correct formula to calculate portfolio returns.
Measuring portfolio returns is not unlike assessing the performance of sport teams. How do you determine the best national rugby team? Do you rely on the current log table? Not all teams play each other often enough for that to truly be an accurate reflection of their capabilities. Do you look at World Cup Results? I know that I’m on thin ice here, but can the Springboks really claim to be the best team after winning with so many close calls? Arguably, other teams were just as competitive, just as close. Even if we decide that they are the best rugby team, does that guarantee future success?
For the same reason, investment performance measurements come with a critical warning: past performance is not necessarily an indication of future returns. Often, a team, or indeed a portfolio, reach the top of the league due to a specific circumstance that may not persist. Perhaps the coach is due to change, or the phenomenal team is composed of aging players soon past their prime. Similarly, portfolio managers change, investments mature and run their course. The future can look dramatically different from the past.
Individual investors rarely receive comprehensive, holistic performance reporting. Consequently, most investors remain unaware of their portfolio’s true performance. Even when they do receive detailed reports, they tend to cherry-pick the most flattering numbers or conveniently ignore the risks involved in achieving those returns.
What truly intrigues me is the motivation for these discussions. What are you trying to say when you brag about portfolio returns? Are you suggesting some magical skill involved in picking managers or investments? Research show that this skill is rare - some studies even argue it’s non-existent. The truth probably reveals more about displaying a lack of understanding of how investments work or how much luck was involved.
In fact, why is the investment environment so fixated on competitive returns when we know that chasing high returns lead to the biggest investment mistakes? Personal investment is not a sport. It is a serious pursuit of generating capital growth – growth that, in most cases, represents people’s hard work. When we talk about investment returns, we should never lose sight of that.
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Kind regards,
Sunél