Sunday, October 28, 2007

Measuring Your Absolute Portfolio Return

There's so much talk and thinking about investing and returns, but what's puzzling is there's no easy tool that I've found to measure your Absolute Portfolio Return. So I built a model.

Passive Investing

In passive investing, you buy index funds and nothing else. Your return is the market return, which over the last 80 years has been about 10%. That's a pretty darn good return, and this strategy takes no mental effort or time to implement - a classic "fire and forget" solution.

Active Investing

In active investing, you are making conscious decisions to execute transactions; to buy & sell stocks, bonds, options, when to apply leverage (use margin). With these transactions comes fees. This strategy also takes up a lot more mental time.

The only reason to actively invest is if you can beat passive investing returns, net of fees, relative to the alternative. Otherwise you're just wasting your time and money.

How to Benchmark your Performance

What's the metric? The problem is that you put money in and out of your portfolio over time - you're not just putting money in once and going from there. But then your true portfolio performance gets complicated to calculate, since your time period changes for each time period. Thus I put together a quick excel model to calculate your true ROI on your investments, versus if you had instead put money into the Vanguard 500 index. If your performance is lower than VFINX, you may as well stop trying to invest actively, and put all your money into the index.

How to Use

1) In the yellow boxes, put in today's information - the total value of each of your accounts (up to 3) and the current share price of VFINX.

2) Then, you need to go back and get your records of when and how much money into the account. In the data below, I've put in my Roth IRA contributions and SEP-IRA contribution dates and amounts. Then, you need to get the adjusted price of VFINX on that date.

3) Click "Calculate Return" and you're done.

If your performance is lower than the S&P 500 Index performance, you should stop trying to beat the market, switch your investments over to an index fund, and go play golf.

The Model

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Sunday, October 28, 2007