In this guide, we look at how we crunch numbers for you and provide two tools to analyze your returns. Plus, see four questions to ask so you understand the overall performance of an investing platform.
But first, don’t fall for fallacies: Typical media coverage may skew your perspective. Avoid these two fallacies when looking at your own investing performance.
The Dow/S&P 500 Fallacy: Benchmarks like the Dow Jones Industrial Average are popular, but they don’t actually tell you much about the stock market. The Dow only represents 30 US stocks. And the S&P 500 doesn’t give you a full picture of the US market—let alone the global market.
The Points Fallacy: It’s common to hear reporters say things like, “Dow loses 500 points.” But it’s far more valuable to look at the percentage change. If the Dow is at 35,000 points, a 500-point drop is less than two percent. That’s not something long-term investors generally need to worry about.
Instead of falling for fallacies: To know how you’re performing relative to the market, ask, “Which market?” Many Betterment portfolios are globally-diversified, making the MSCI All Country World Index a better benchmark than the S&P 500 or Dow.
How Betterment simplifies looking at performance: We crunch the numbers for you, showing you three aspects of performance.
Your combined accounts. We pull together all of your accounts and show their performance as one number. You can also zoom in on the account level.
Your total returns. Since changes in the prices of assets in your portfolio are more volatile, and don't tell the full picture, we look at total returns which include price changes and dividends together instead of breaking them out separately.
Your long-term timeline. We show your performance over as long a period as possible to help keep you focused on the long term and minimize short-term stress.
Two tools to analyze your returns: We don’t encourage frequent monitoring of performance, but when you do want to review performance, we have two tools to help you understand the big picture.
Tool #1: Time-weighted return. Time-weighted return is the default return you see on your Betterment accounts.
When you invest, you often have deposits made over time. The time-weighted return imagines that all deposits were made on your first day of investing.
Why would you want to do this? Because cash coming in and out of your portfolio at different times can distort and complicate your returns due to the nature of the constantly-fluctuating stock market.
Also, if you were comparing returns across two different accounts with two different cash flow patterns, you couldn’t be sure if the difference was due to the investments or due to the timing of the cash flows.
The time-weighted return can refer to a price-only return or a total return. Price return reflects only the change in the price of the asset, while total return reflects both price and reinvested income.
By default, Betterment displays the total return for a more comprehensive view of performance.
Tool #2: Individual rate of return. Individual rate of return can be displayed on the performance screen of each account by clicking on the “Show balance details” link.
The individual rate of return is affected by each and every instance of cash flow that goes in and out of your portfolio.
Cash flows at Betterment can include deposits, withdrawals, dividends, and fees.
Individual rate of return does a better job of answering the question, “What are the average returns on the dollars I personally deposited into Betterment?” as opposed to “How well does Betterment design and manage the portfolios I have with them?”
Looking beyond returns is important when considering an investing platform or fund. Here are four questions to ask:
What are the commissions, trade fees, and assets under management (AUM) fees?
How much time and effort are required of you to manage the investments?
Does the investing philosophy align with your values?
Does the platform offer tax efficiencies such as tax loss harvesting and asset location? (Note: Your stated returns likely won’t take into account any potential value these tools may have added.)
The amount of time you hold an investment significantly affects its returns and value. Short-term investments have less time to grow and can be affected by temporary swings in the market. Long-term investments generally provide higher returns as they have more time to increase in value and compound.
To help with this conversation, I like to frame fund expenses in terms of what I call the Four C's of Investment Costs: Capacity, Craftsmanship, Complexity, and Contribution.
The key performance metrics and ratios for investment performance include Return on Investment (ROI), Compound Annual Growth Rate (CAGR), Sharpe Ratio, Information Ratio, Jensen's Alpha, Sortino Ratio, and Treynor Ratio.
Return on investment (ROI) is an approximate measure of an investment's profitability. ROI is calculated by subtracting the initial cost of the investment from its final value, then dividing this new number by the cost of the investment, and finally, multiplying it by 100.
What does the 4% rule do? It's intended to make sure you have a safe retirement withdrawal rate and don't outlive your savings in your final years. By pulling out only 4% of your total funds and allowing the rest of your investments to continue to grow, you can budget a safe withdrawal rate for 30 years or more.
Overall, you need to understand 4Ms, including the Margin of Safety, Meaning, Moat, and Management. In this episode, our guest helps us gain a better understanding of each so you know what to look for before you invest.
Return and risk always go together. The higher the potential return, the higher the risk. You should never blindly pursue high-return investments. Bear in mind your investment goal, investment period and risk tolerance.
The statement might show your returns as a percentage. These changes can come from market movements or dividends and interest you earn. Additions and withdrawals: Get a quick summary of how much money went into your account and how much came out. Withdrawals might be from your activity or from fees in your account.
Most investors would view an average annual rate of return of 10% or more as a good ROI for long-term investments in the stock market. However, keep in mind that this is an average. Some years will deliver lower returns -- perhaps even negative returns.
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