My Personal Finance Journey

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My Key Portfolio Performance Metrics

Contributed by mm | March 30, 2003 8:03 AM PST

In the last several months, I have been thinking and refining my key metrics to evaluating the performance of portfolio.

First, I only want to use the performance of my actively managed portfolio, which consists of my regular brokerage accounts and Roth IRA account, as a yardstick of my personal investing success (or failure). I'm not including the ESPP account because as I'm consistently adopting the immediate-sell strategy, a sizable profit is almost guaranteed. I also exclude 401(k) because the investment options are very limited and successful 401(k)investment requires more a macro-economics view rather than stock picking.

Second, I'm choosing S&P 500 index as my sole benchmark of my performance. I believe S&P 500 offers the best reflection of general market performance among the three major indexes (DJIA, NASDAQ and S&P 500). As I'm still in the very early stage of my wealth accumulation, I'll be happy to accept the extra risk in the equity market (compared to fixed income market). In this sense, S&P 500 should be the best way to measure if my extra labor in portfolio management is worthwhile.

Third, I believe under my specific circumstances, it's best to track the performance of invested component of the portfolio only without considering the cash component. Of course I almost never fully invest all of my available cash. But on the other hand, as 1) I consistently move all cash balance in my brokeage accounts to my money market or saving accounts for best interest rate, and 2) I am always putting a small pile of emergency cash, it is very hard to find a consistent and reasonable way to aggregate the total available cash for investment, not to say how to include the interest income from various checking and saving accounts into the aggregation. Furthermore, as I'm adopting S&P 500 index as my benchmark, which itself assumes 100% fully invested scenario, calculating only the performance of the invested part of the portfolio makes more senses to ensure apple-to-apple comparison.

Based on the above philosophy, I'm adopting those metrics in evaluating my portfolio performance:

Absolute Annual Rate of Return

Absolute ARR is the annualized return rate of the portfolio. It is calculated by using the XIRR Excel function on all the cash flows that happened in the actively managed portfolios (including tradings and dividends), plus treating the current value of the portfolio as a positive cash flow, representing the fact that the portfolio can be liquidated immediately for that amount of cash (commissions ignored). To calculate the absolute ARR for a particular year, the total portfolio value at the end of last year is recognized as a negative cash flow, representing the cost to reestablish the positions immediately at the year start.

Of course, the goal is to have the highest absolute annual rate of return without introducing unnecessary risk.

Relative Annual Rate of Return

Relative Annual Rate of Return is the number of percentage points my absolute annual rate of return beats or is beaten by the benchmark S&P 500 index.

In general, I'm expecting to beat S&P 500 index by at least 3 percentage points every year.

Net Profit (Loss)

Net profit or loss is the profit or loss in my portfolio during a certain timeframe. It may include unrealized gains or losses. This is an absolute dollar amount meausre of how much I earn or lose in the market.

# of Transactions

This is number of transactions (including both purchase and sale) in my portfolio in a given period of time.

In the long term, I hope to limit my transactions to 10 trades per year or less. In the short term I might need to trade more frequently as I'm consistently adding cash to my portfolio and trying to diversify enough.

Annualized Turnover

Annualized turnover is the asset turnover rate in the given timeframe, annualized. It is another measure that tracks how quickly I make trades and shuffle positions. It is the annualized rate of Turnover Rate, which is defined as follows:

Turnover Rate = Total Dollar of Transaction in the Period (including trades and dividends) / Sum of Net Portfolio Value at the Start and End of the Period, annualized.

In the long run, I expect to keep turnover rate for any given year below 100%.

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