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Comparing Your Statement Return to a Benchmark Index

Comparing Your Statement Return to a Benchmark Index

If you watch a financial news channel, you might hear the return of common indices like the Dow, S&P 500 or TSX60. These indices are meant to give you a snapshot of how the general stock market is performing over the day, month or longer timeframe.  It's difficult to compare a return on a portfolio to an index for two reasons, (i) you can't directly buy an index and (ii) most investors have a portfolio that is very different than a single index. The typical investor will likely hold some cash, fixed income (bonds) and equities such that the the investor portfolio is less volatile than an all equity portfolio or index like the DOW.  To learn more about the DOW, click here. I also posted a recent article where you can learn more about Warren Buffett and Berkshire Hathaway's portfolio that you might find interesting.

Index returns are snapshots in time that assume you invested all your money on that particular day. But that's not what investors typically do!  If it's an RRSP, you may add money monthly, annually and in varied amounts and even different currencies. Does that affect the return? Absolutely and I'll demonstrate using the following scenarios assuming you could invest in an index.

To setup the analysis, I assume an investor has $100,000 and their investment time horizon is 11 years beginning on January 1, 2009 and ending on December 31, 2019.

The return for each year (shown in grey below) was imported into a custom spreadsheet which allowed me to input a starting value of an investment and then calculate the return over the time frame, both in (i) cumulative dollars and (ii) annual compound rate of return. From this I can simulate different scenarios. Data was obtained from publicly available information at Macrotrends.net.

Scenario 1: Lump Sum Investment

The orange box below shows a lump sum investment of $100,000 on January 1, 2009 and at the bottom, right hand side of the table, the orange box shows the value after 11 years. The initial investment of $100,000 grew to $325,214.46 or just over triple in value over 11 years. The annual compound rate of return is 11.3% .  As previously mentioned, index returns are snapshots in time that assume you invested all your money on that particular day. But that's not what investors typically do!  If it's an RRSP, you may add money monthly, annually and in varied amounts and even different currencies. Scenarios 2,3,4 and 5 below show the wide difference in ending value and compounded annual rate of return.

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Scenario 2: Initial Lump Sum and then Equal Annual Deposits
In this scenario, the investor decides to initially commit $50,000 to the market in Year 1 (2009) and then $5,000 each year from 2010 to 2019 for a total investment of $100,000.  The result  the total investment is worth$255,105.11by Dec 31,2019 which  is an 8.9% compound annual return.

Scenario 3: Equal Annual Investments

In the table below, $100,000 is invested over the 11 years but in even amounts, or $9,090.91 each year. The result show the net investment of $100,000 grows to $197,742.91, almost doubling. The annual compound rate of return is 6.4%. So it's important to note that changing the investment frequency changes the rate of return dramatically.

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Scenario 4: Lump Sum Investment at Year 6

This time the investor waits until year six to make the initial investment of $100,000. The result is a final value of $172,176.87 or a compounded annual return of 5.1%.

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Scenario 5: Lump Sum Investment in Year 11

This time the investor waits until year 11 to make the initial investment of $100,000. The result is a final value of $122,340 or a compounded annual return of 1.85%.

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Summary

The scenarios above show that depending when you invest your money, the future value of your portfolio and the compound rate of return will also vary widely. Scenario 1 which invests the most money initially, does have the highest return over time and largest final portfolio value.  The "sequence of returns" also played a major factor as well as there were only two (2) in 11 years that were negative and those negative years were relatively low. The scenario's returns ranged from just between about 2% and 11% over the period.  

So while indices are useful to get a sense on the stock market performance, it's difficult to gauge your portfolio performance against them.  Because a retail investor's portfolio tends to hold cash, bonds and equities, they will underperform the index when the index is up but conversely will lose less when the index does poorly. In the end, it's about having a portfolio that best matches your risk profile and financial goals. 

Note to readers who are clients.

The quarterly statements that are provided to clients do provide a bar chart that compares your actual performance to a "blended benchmark" for different time periods. It's difficult to explain in words, so please contact me and I can show you on your personal statement.

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