I get the opportunity to interact with investors because of my chosen line of work, and therefore observe the basis on which they choose their investments, and how they analyse, assess, revisit and rebalance their portfolio.
My conclusion is that investing is akin to health. People pay attention to it only when they have lost it or they are in a major muddle. A health scare spurs people to exercise and look after their diet. I think a lot of investors mindlessly invest their savings. They revisit investment options when they have a need to enhance their financial health seeing that many of their friends, family & colleagues who have been consciously investing make good returns on their investments.
As in health, where people who embrace an active lifestyle are much better off than people who are sedentary, financial health for people who actively invest as a habit is much better than people who do not invest as a habit.
Again as in health, where a regular health check up is recommended especially for people who lead sedentary lifestyles, investments too require a regular health check up.
Health Check Up on Your Investments
How do you do a Health Check Up on your investments? Like in physical health check up, there are certain standard tests that are benchmarked to set parameters. If test results are within the parameter’s you are fine but if they are outside the parameters you need to go to your doctor or in this case your financial advisor.
Standard Tests for your Investments
First test is to take all your investments and separate it by asset class. For example if you have Rs 100 that you have invested in equity, fixed income, gold, property then you check how much you have invested in each. If you have invested Rs 10 in equity, Rs 50 in fixed income, Rs 20 in gold and Rs 20 in property, then your investment weights are Equity 10%, Fixed Income 50%, Gold and Property 20% each.
With this basic tests, you then judge the parameters. What are the returns you have received from each investment.
It may sound very simplistic more often than not its always simple return especially in stocks.
The difference of price at which a stock is bought, price at which it is sold, or the current value /purchase Price *100
For eg : Simple Return : Selling Price – Cost price /Cost price *100
Cost Price – 100
Selling Price /Current Value – 150
Simple Return = 150-100/100 * 100 = 50%
This is simplest form of return calculation, doesn’t take into account of the holding period, alternative opportunities, performance of benchmarks, nothing.
The other common way of calculation is how much return you have earned per year, or CAGR or compound annual growth rate. The concept of CAGR is relatively straightforward and requires only three primary inputs: an investment’s beginning value, ending value, and the time period. The CAGR represents the growth rate of an initial investment assuming it is compounding by the period of time specified. Specifically, the formula is
Going by the same example above, if the value of the investment has gone up from 100 to 150 over two years the calculation will be
CAGR = ((150/100))^(1/2)-1 *100
which works out to 22%.
There are other factors like any dividends received which can be factored in while calculating the CAGR.
Practically, the above measures are good and used but they still don’t address the issue of how to calculate return of the portfolio as investors , invest at different points in time different amounts.
NAV Based Approach is the Best for of Measuring Investment Performance
Investors use weighted average or any of the above methods but I have found this method to be the easiest and the most uncomplicated way of calculating returns when investments are made at different times and portfolio value keeps changing.
Say, you begin on 1/1/2016, with Rs. 1000 and invest in different scrips.
Subsequently there are investments at different dates of varying amounts at different portfolio value, you can see it in the charts.
You start with Portfolio Value of Rs. 1000, investment of Rs. 1000 . NAV will be 1000, Units outstanding will be 1.Units = Value of Investment/NAV.
When you subsequently invest , divide the fresh investment by the portfolio value and get the units.
The return can be calculated by difference between NAV at the beginning, NAV at the end .
Based on the NAV thus generated , any type of return can be calculated, simple, CAGR if you take the dates of investment into consideration,if you take into account the dividends etc (cashflows) then XIRR.
Compare that to the benchmark, ie either Sensex or Nifty for the same period and you have your return as against it.Easy to know if your portfolio is outperformed or underperformed the benchmark. Run the health test, judge the performance of your advisor and your fund manager based on the above.
Do you want a Health Check Up of Your Investments? Contact me firstname.lastname@example.org for details of our Investment Health Check Up Services.