How to Measure Your Investment Performance

As the fall semester draws to a close at Seton Hall University (where I teach), it's time for me to submit grades for my students' performance. This is never an easy process. However, what I have found in academia and in my role as a registered investment advisor at LakeView Asset Management is that it is necessary to devise an objective measure of performance.

Many installments of The Finance Professor mention the concepts of investment performance measurement and investor accountability. Now I will elaborate on those notions by discussing an essential guide to investment-performance measurement. Here is what is necessary:

Define a Time Horizon

Investors will typically judge their performance on an annual basis. However, you may decide to divide an annual period into quarters and maybe even months.

Whether or not your long-term investment horizon is more than a years away (for example, you may be financing retirement or college), you should still measure your performance annually.

Should you want more time granularity in the future, I suggest you start out with shorter time periods to avoid having to go back later.

Keep Detailed Records

Performance calculations are not as easy as taking the difference between an opening balance and a closing balance, dividing by the opening balance, subtracting one (1) and displaying it in percentage terms. The reason is that a series of cash flows may take place between the beginning and the end of the investment period.

Let me illustrate with a simple scenario. Say you start out with $100,000 on Jan 1 and end with $1,000,000 on Dec 31. During the year, you added $850,000 to the account. Did you make $50,000 on a $100,000 investment or did you make $50,000 on a $950,000 investment?

The answer is both and neither.