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%.

Grade B: Return performance beat your benchmark by at least 0.25%, but less than 5%.

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%.

Grade F: Return performance was substantially below your benchmark, by more than 5%.

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.

None of this is to say that you should not be flexible in your investment and risk management. But consistently evaluating how your investments stack up against your specific benchmark will require not falling prey to style drift. Bottom line: When the market goes wild, be careful how you play it because style drift may impair your judgment in the future, when a return to your core investment style would be optimal.

2. Missing Twists and Turns

2008 had more twists and turns than the Le Mans race course. Oil and commodity prices reached record highs only to fall dramatically to multi-year lows. Financial companies already hurting from the subprime credit crisis had to turn to the government for "TARP" and other government-led bailout programs. A deepening recession hit consumers' demand for goods and services. Unemployment soared and GDP growth sank. A symptom of all of these market conditions led to one of the most volatile markets ever.

This was not an easy year to navigate. Personally, while I trimmed many of my oil and commodity holdings in May, I held onto positions which were roughly in line with the market weighting.

Financials were best left to avoid for most of the year. However, as measured by the Financial Select Sector SPDR (XLF) - Get Report ( XLF), this group of stocks recentlly rebounded by 36% off of its lows (as of the end of business on Monday). Few investors were able to take advantage of this bounce as they remained out of the sector for fear of even more bankruptcies or near bankruptcies, such as Lehman Brothers, Bear Stearns and American International Group ( AIG) (AIG) - Get Report .

During all of this economic mayhem, volatility as defined by the CBOE Volatility Index (VIX.X) rose to multi-decade highs.

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If your style is not to trade volatility or price ranges, then it is likely that your performance suffered this year. As I mentioned before, if you did not catch the twists and turns and volatility of 2008, don't worry. You were not alone.

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3. Unforeseen Liquidation

(XLF) - Get Report (AIG) - Get Report If many of your well-researched and favorite stocks were abruptly sold off by "the market" this year, then you might have been a casualty of leveraged liquidations. This was particularly true for those energy, commodity and agricultural stocks that were owned by hedge funds.

In "Hedge Fund Liquidations: Five Things You Need to Know," I discussed how hedge funds could impact you, the individual investor. And in 2008 many individuals and "pros" felt the damage of hedge funds that needed to meet redemptions and reduce leverage.

(XLF) - Get Report (AIG) - Get Report While this may not seem to be rational behavior, we have to accept that it did occur and the impact is probably being felt in our year-end investment evaluation. However, do not throw traditional valuation to the wind. Eventually, the hedge fund liquidations will cease and security prices will revert to more normal behavior.

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4. Fixed Income Is Not Risk-Free

(XLF) - Get Report (AIG) - Get Report Before 2008 it was conventional wisdom that fixed income investments were more or less "safe." But like the Discovery Channel's Mythbusters, the markets in 2008 busted the safety tenant of the fixed income myth.

Unless you invested in U.S. Government debt or obligations of certain states and municipalities, then you learned the hard way that losses in fixed income could be severe and, in many cases, more dramatic than stock market losses.

(XLF) - Get Report (AIG) - Get Report Many investors tried to chase yield by investing in mortgage-backed or low rated debt instruments. This may have been the root cause of underperformance in many fixed income or "blended" portfolios.

Your Homework

Calculate your annual investment performance for 2008. Make sure you compare your performance to a specific (and relevant) benchmark.

Determine the cause of your over- or under-performance this year.

Ascertain if you subjected yourself to style drift and if so, realign your portfolio to get back on track for 2009.