Three Chances at Getting it Right (or Three Chances at Getting it Wrong…)

Fiona Clark, 14 June 2013

How do you judge if you’ve done a good job with your investments? Benchmarking an investment portfolio might sound like a really simple concept but the possibilities are varied depending on what you want to achieve. I’ve narrowed it down to three basic categories and for the purposes of this comparison I’ve ignored the composition of returns (i.e. income versus capital), which adds another layer of complexity…

1) The equivalent asset benchmark: This is the most common for investment professionals. Whether it’s the All Ordinaries Index, an MSCI or Property Council calculated benchmark, it’s a weighted average performance measurement of the assets we COULD invest in. It’s not perfect – big companies get a higher weighting with shares indices and if you only wanted to invest in NSW properties in your suburb the NSW average property index won’t quite reflect your experience – but it’s the best we’ve got for now.

2) The alternative asset benchmark: Not as obvious but most of us actually apply this to our own investment experiences. Also known as the “opportunity cost” performance benchmark, it’s the feeling you’d get if you moved all of your assets into term deposits just before the share market took off; or losing money in shares in the GFC while your neighbour’s property investment kept bringing in the rent and kept most of its value. Investment professionals tend to ignore this type of benchmarking – it’s an asset allocation decision in which they don’t really have a say. But each of us as individuals, managing our own investment portfolios, must face this comparison.

3) The “Do Nothing” benchmark: Investors in “riskier” asset classes like equities are familiar with the skewed risk profile – they want to beat the benchmark when it’s strong and they don’t want to lose money when the benchmark falls (outperformance is suddenly irrelevant!).Whether your absolute measure is “losing money”, beating the cash rate or – my favourite – being better than paying off the mortgage (which makes it a little more challenging), the theme is the same. We want to know that we got a better result for all our hard work than if we had taken the easy option of doing nothing.

So we’ve given ourselves three hurdles to “beat” – a relative hurdle, an opportunity cost hurdle and an absolute hurdle.Three chances to get it right…or wrong. Dare I suggest another hurdle? In the famous lyrics of “Meatloaf”, should we comfort ourselves if we are manage to apply the mantra “Two out of three ‘aint bad”?

I’d be really interested in hearing if I’ve missed anything, or your thoughts on the benchmarks you use to judge your investment performance. Email me at fjclark@primevalue.com.au