Do You Really Know How Your Investments Are Doing?

There are many ways to evaluate investments. One way is simply to look at the monthly statement from your custodian and see if you gained money or lost money. The other way is to look at the quarterly performance statement from your investment advisor, money manager, or investment manager. The quarterly statement seeks to explain fluctuations in value and offers comparison information to certain benchmarks you and the manager have selected.

Custodial statements

Some popular companies that act as custodians are TD Ameritrade, Charles Schwab, E*Trade and Fidelity. Many such companies also offer financial advice, but when functioning as a custodian, they act essentially like a bank. Typically, that connotes a place that has bars in concrete to keep out people you don’t want touching your money. In this case, your stocks, bonds, mutual funds, etc. sit with a custodian for safekeeping. The custodian keeps up with any money that may have been deposited into the account, such as proceeds from the sale of stocks, bonds, mutual funds, etc., and tracks any monies that may have been withdrawn, because of stock or bond purchases, for example. There may be debits due to fees or discretionary withdrawals as well.

The custodian, who gets paid for keeping your money safe, generates monthly statements that are intended to help you understand the additions and subtractions from your account. But the custodian does not act as an investment advisor or investment manager. (This can be confusing when the name of the investment company and the custodian are the same.)

If you evaluate your investment performance using the custodial statement, you can verify that no unauthorized transactions occurred, and you can see whether your investments went up or down, but that’s about all. So, the only question you can answer is “Did I make money or lose money?” Custodial statements are not very enlightening when it comes to the return on your investments, especially when compared to the information you get from an investment advisor or investment manager’s report.

Investment management performance statements

As a proponent of modern financial science, I strongly believe performance statements provide more insight into your investments than custodial statements. This approach enables you to look not simply at whether you made or lost money but at the percentage return of the portfolio. You may view that return for individual investments or for your portfolio overall. (Assessing the percentage of return is beyond the scope of this article.)

When taking a modern financial science approach, you consider not only the return of the investment but also its risk. This is often called a risk-adjusted return because it acknowledges that there is risk related to your investments. You may not have experienced the risk, but that doesn’t mean it wasn’t lurking.

A risk-adjusted return lets you assess the appropriateness of your portfolio, given the amount of fluctuation you are comfortable with or are seeking. The idea of portfolio construction or asset allocation is to mix together different types of investments in order to smooth out some of the up and down movement of your portfolio. Looking at risk-adjusted returns can help you compare different portfolios. Two portfolios may have delivered the same return, but the roller-coaster ride to get there may have been completely different. You may simply see risk as how much or how little your portfolio fluctuates. Proponents of modern financial science use the term standard deviation to quantify that up and down fluctuation. When comparing portfolios of similar return, the portfolio with the smaller standard deviation has a lower risk adjusted return.

Unlike custodial statements, which come out monthly to help you determine whether there was any unauthorized activity or to confirm what you expected, investment performance reports are generated quarterly. However, that doesn’t mean you should look at them quarterly. Professor Daniel Kahneman, who won the Nobel Prize for something called behavioral economics, or behavioral finance, has a different take. He says that looking quarterly at the report from his investment advisor makes him want to tinker with his holdings, which may be harmful to returns. So, he looks on a less frequent basis to help control his desire to mess with his investments. (You may find it interesting that someone who won a Nobel Prize in finance uses a financial advisor. But he’s wise to do so, since, in addition to standard deviation, there are other mathematical ways to look at your portfolio, such as beta, alpha Sharpe ratios and more. Assessing your investments in all these ways is time consuming and, yes, emotional. Kahneman may want to free up his time—and have the benefit of a calming voice, too.)

What’s your investment expectation?

If you don’t have the time or know-how to evaluate all of these things and, like Kahneman, you want to avoid the temptation to tamper with your investments every time a performance report comes out, I recommend finding someone who can help you understand the complexities of your investments and temper any temptations to tamper with them. You may want to do so without your real money on the table if that tends to make you nervous.

At the outset of your engagement with your investment advisor, you should agree on expectations and set targets you’d like to hit in terms of return. This conversation should also include what ups and downs you expect and are willing to accept in the market. I believe in only taking the amount of risk necessary to achieve your objective. Your comfort with investment risk may be lower than the risk you need to take, given your savings and timeline. If your current tolerance is significantly lower than the risk tolerance needed to reach your goal, you may need more education—or to join Dr. Kahneman and not look at your investment reports.

In my experience, people buy on the expectation of positive returns and sell when they see results start to go the other way. In the world of investments, however, you don’t lose money until you sell. While you might not want to delve too deeply into the world of risk and return, most of us cannot reach our long-term goals without it.

Hopefully this article has helped demystify the types of reports available to evaluate your accounts. It’s important that you know what to look for in the various reports you receive so you don’t make the wrong decision at the wrong time, impairing your financial future.

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I help middle to upper income Americans experiencing money uncertainty pursue joy through smarter money moves. I am a Certified Financial Planner™ (CFP®) and CEO of Env

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