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How to Evaluate Your Portfolio This Year

As 2008 winds down, it is time once again to take that annual retrospective (and introspective) look at your investment portfolio.

In " How to Measure Your Investment Performance," I presented my grading system for evaluating your investments. To refresh your memory, the following is my system. (Please note: Performance should be calculated after you subtract all fees and expenses.)

  • Grade A: Your rate of return substantially outperformed your benchmark by more than 5.00%.
  • Grade B: Return performance beat your benchmark by at least 0.25%, but less than 5.00%.
  • Grade C: Return performance met your benchmark (or was within a reasonable margin of +/-0.25%).
  • Grade D: Return performance was below your benchmark by at least 0.25%, but less than 5.00%.
  • Grade F: Return performance was substantially below your benchmark, by more than 5.00%.
  • You can add a plus (+) if you were profitable or a minus (-) if you lost money.
  • My grading system is relative, but it also takes a little absolute performance into account.

    Now if you did poorly this year, do not fret. You are not alone. In 2008 the major indexes performed at their worst in nearly 80 years.

    What is important for you now is to understand what happened this year and recognize any investment mistakes that you may have made over the last 12 months. So let's take a look at four major factors that were characteristic of 2008 and may have contributed to your investment performance (for better or for worse) this year.

    1. Style Drift

    Maintaining a consistent investment style, with a consistent benchmark, is one of the keys to laying a foundation for investment management and performance. However, there is a tendency to try to switch from a previously targeted benchmark to a different benchmark just because market conditions have changed. This usually occurs during periods with either very good or very poor market conditions. In the investment world we refer to this as style drift.

    Style drift is where a portfolio manager attempts to "chase" performance by deviating from their stated investment style. For example, if you are a growth manager and you switch to a value orientation because value is "in vogue," then that's considered style drift. If you've always called yourself a fundamental investor and you decided to invest based on technical chart patterns, then you have committed style drift.
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