How to measure your investment performance? -The Right Way
Hello Readers. Honestly, we at Trade Brains love cricket!. We also happen to love following the latest records and comparing statistics of our favorite players. Which of our players are the most consistent? Who is more likely to score runs and how often? Who plays better against spinners? And who works best on a flat pitch?
Well, these are just some of the questions that we keep asking ourselves right?
This got us thinking, is there anyway, we as investors, could borrow from the sport and rate ourselves? And can we make ourselves as better investors through a defined process? After all, introspection is the best critic we have on our side right?
In this post, we will be covering the different metrics and techniques, we as investors, can use to measure our performance and hopefully identify and strengthen the weak spots in our investment process. An over the top view of the toolkit is as follows:
- Slugging rate
- Holding Periods
- Performance relative to the benchmark
Overall, this post will give the best ever solution to measure your investment performance. So, without wasting any further time, let’s get started.
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How to Measure Your Investment Performance?
Here are the four best and easy metrics that you can use to measure your investment performance over the years in a right way.
1. Hit Rate
Broadly defined, hit rate is the percentage of profitable investments to the total number of attempted investments.
The keyword in this metric is “attempted investments”. Many a time, retail investors do more harm than good to their portfolios by investing in stocks they do not understand in an attempt to diversify their portfolio. This approach could result in below market performance for the investors in the long run. A better approach would be to make infrequent but highly probably bets in the market.
This sentiment is also paraphrased by master investor Warren Buffett through one of his famous analogies comparing investment performance to playing baseball.
“What’s nice about investing is you don’t have to swing at pitches. You can watch pitches come in one inch above or one inch below your navel and you don’t have to swing. No umpire is going to call you out. You can wait for the pitch you want. In investing, just as in baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard. I’ve never swung at a ball while it’s still in the pitcher’s glove.”
– Warren Buffett
2. Slugging Rate
Quite simply this is a measure of how much you profit when you win and how much loss you incur when you don’t.
Logically, any investor who wishes to make positive returns will have to ensure that their gains outdo their losses. The more the outperformance of the gains the better the returns will be for the overall portfolio.
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- 14 Most Frequently Asked Stock Investing Questions by Beginners.
- Bunty and Babli: A financial story of how Bunty lost Rs 1,29,94,044!
3. Holding Period
Although most investors think they need not use this statistic to measure their performance, we at Trade Brains, believe otherwise.
Ideally, you as an investor would want to hold on to your winning picks and exit your losing stocks quickly. While, this doesn’t mean that you drop a stock just because it went down immediately after you bought the stock, a stock that drops 40-50% should be treated as a red flag and reviewed before taking a decision on whether to continue holding the stock or not.
4. Performance relative to the market benchmarks
Since most investors seek to beat the market over time, it would make sense to measure your portfolio’s performance against broader market indices such as NSE Nifty 50 or BSE Sensex.
The performance relative to the market indices can help you decide whether you need to increase your exposure to mutual funds or stop investing on your own entirely.
For a portfolio composed of predominantly large-cap stocks, it would make sense to compare the portfolio relative to large-cap indices (and similarly for mid-cap and small-caps).
But what if your portfolio had exposure to large, mid and small cap segments of the market?
Let us understand the method of evaluation through the following example.
Assume that an investor has 30% exposure to large-cap stocks, 30% to mid-cap and 40% to small-cap stocks.
The best method for evaluating such a scenario would be to take the weighted average returns of indices to measure one’s portfolio performance.
|Market Segment||Market Index||3-year return||Portfolio exposure|
|Large Cap||BSE Sensex||54.20%||30.0%|
|Mid Cap||BSE Mid Cap||62.90%||30.0%|
|Small Cap||BSE Small Cap||62.2%||40.0%|
The weighted average returns of the indices for a similar market exposure as the portfolio will be given by the following expression-
Weighted Average returns for 3 Years = [(large cap exposure x large-cap index return) + (mid-cap exposure x mid-cap return) + (small-cap exposure x small-cap return)] x100
= [(30.0% x 54.20%) + (30.0 %x 62.90%) + (40.0% x 62.2%)] x 100
= [0.1626 +0.1887+0.2488]x100
If the investor’s portfolio achieved returns greater than the 60.01% in three years (that would have been achieved by a similar exposure to the market benchmarks), then it is best for him to continue investing on his own. Otherwise, it would be better for the investor to allocate his capital to Index Funds with similar weighting or change his/her investing strategy.
The financial markets are fantastic yet dangerous places to grow your wealth over a lifetime. Any investor who wishes to play the game for the long term will have to continuously adapt their investing process to achieve the most optimum returns.
We hope our readers will add the above methods to their toolkit for measuring portfolio performance. Happy investing.
Levin is a former investment banker and a hedge fund analyst. He is an NIT Warangal graduate with around 5 years experience in the share market.