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Optimizing your portfolio performance is the key goal for most investors. In addition, of course, you want to make the most of your investment return, whether you're an aggressive or conservative investor. But, many investors wonder whether they should use an advisor or DIY their investment approach.
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What Is an Investment Portfolio?
An investment portfolio is the combination of all the assets you own. For example, you might own stocks, bonds, mutual funds, commodities, and real estate. These assets make up your portfolio, and the more you diversify it, the more likely you will reach your personal finance goals.
When you create a portfolio, you should consider your time period, financial circumstances, and risk tolerance. In addition, there are different ways to set up portfolios, including in a 401K, IRA, or taxable brokerage account.
A financial advisor or even a tax professional isn't required to create an investment portfolio, but there are certain benefits if you do.
- Saves you time - Working with an advisor means you don't have to do as much research on different investments and investment strategies. You can trust the advice of your advisor when making investment decisions.
- Advisors may have more advanced strategies - Investing involves risk, but your advisor may have more strategies you can use that enhance your portfolio return without taking too much risk.
- You get a hands-off approach - You don't have to watch your stock portfolio like a hawk and make big decisions. Instead, you can relax knowing your advisor is watching the portfolio's performance and will adjust the asset allocation as needed.
- It can be unsettling - Leaving your personal financial situation in the hands of a stranger can feel unsettling. Unfortunately, no one can guarantee investing returns during any time period. They can do their best to achieve your desired overall performance, but there's never a guarantee.
- There can be a conflict of interest - If you don't do your research and ensure you're working with an advisor acting as a fiduciary, you may get biased opinions. For example, the advisor may suggest other investments he has a stake in or make him more commissions than other investments that might suit your portfolio investment better.
- The cost can be high - Advisors don't work for free. They might charge commissions for every transaction or a percentage of your assets under management. Always read the fine print to understand the total cost and what you'll pay even when you lose money.
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You always have the option to create an investment portfolio without an advisor. However, like working with an advisor, there are pros and cons.
- No pressure - You don't have to worry about buckling under the pressure of sales tactics or strong suggestions to invest in certain assets. Instead, you can make investment decisions and manage your portfolio's return.
- Fewer expenses - Because you aren't paying a middleman to hand your investment decisions, you may save money on fees. This leaves more of your portfolio income in your pocket, not someone else's.
- You may have more choices - Advisors usually have a limit to the investments they can offer for your investment portfolio. However, when you DIY your investments, you can invest in any asset class or asset you want.
- You may take the wrong investment approach - If you don't understand investing returns or how to manage your risk tolerance, you might take the wrong approach and lose more than you make, not realizing the portfolio return you hoped for.
- You may get emotional - Using a portfolio tracker and watching your portfolio performance can sometimes be disheartening. You may find that you react too soon or take too long to react, negatively impacting your portfolio performance.
- You may put too much pressure on past performance - Historical performance can give you an idea of what an investment performance might do, but it's not guaranteed to follow the same path. So putting too much weight on historical performance and not understanding how to calculate portfolio returns for the future can be detrimental.
Measuring Portfolio Performance
Measuring investment performance is important when assessing your portfolio. To evaluate a portfolio's performance, you compare it to a benchmark portfolio.
Here's what to consider.
A portfolio's total return is the combination of incremental income, such as dividends or interest earned throughout the period, plus any capital gains earned when you sell the asset. This portfolio return gives you the big picture.
Absolute and Relative Performance
Absolute returns are the total return from a portfolio after the income generated from interest or dividends, plus capital appreciation.
The relative performance compares the absolute performance to specific benchmarks or portfolios. This helps you determine the portfolio's performance to measure how it performed compared to other options.
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Rolling returns look at a portfolio performance's long-term returns versus a stagnant period. Rolling returns consider returns over several time periods, some of which may overlap. This gives you a better outlook on how an investment performs over time.
Time Weighted Return and Money Weighted Return
Time-weighted return calculates the compound growth over a specific investment period for each dollar invested. Therefore, it must be recalculated each time money comes in or goes out of the investment.
Money-weighted return, or the internal rate of return, is the discount rate for all money invested today, given its future returns.
Factors Affecting Investment Return
No one can guarantee how an investment will perform or if it will perform how you anticipated. But, understanding the factors affecting investment performance can help you minimize the risk of loss and maximize your portfolio returns.
Your behavior has a large effect on investment returns. If you are the type that panics and bails fast, you might miss out on an opportunity to ride the roller coaster back up and earn more money.
Often, investors see a poor investment performance and prematurely sell their investment, not giving it a chance to come back.
The earlier you invest, the more time your money has to grow, and the longer you keep your investment in your investment portfolio, the more time it has to provide positive returns. That's why most advisors encourage anyone with a stock portfolio to make it a long-term investment, not something they will sell in the short term.
The more diversified your portfolio is, the easier it is to reach your financial goals. In addition, when you have individual investments that perform poorly but have others that offset the losses, you reduce the total loss.
All investments have fees of some sort. Some charge commissions, and others don't, but they all have underlying costs that decrease your profits. Understanding the investment fees and how they affect the whole picture can help you create the perfect portfolio investment.
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Portfolio Analysis: FAQs
What Is the Average Rate of Return on Stocks?
For the last 100 years, the average rate of return on stocks has been 10% when they are held in an investment portfolio long-term. Of course, the annual return can vary greatly depending on what's happening in the economy, but overall, investors earn a 10% return.
Why Is Portfolio Performance Evaluation Needed?
A portfolio performance evaluation is important to determine how a particular portfolio performed. For example, did it go as planned, or did the investor come up short? This performance measure can help investors decide how to proceed with their portfolio or how to build a new portfolio.
What Is the S&P 500 Benchmark?
The S&P 500 is made up of the top 500 large-cap companies. It's the most common benchmark for many investments, as it tells the story of the economy's overall health.
What Are Portfolio Metrics?
Portfolio metrics tell the entire story of portfolio performance. Of course, the total return is one piece of the pie, but many other metrics, such as time horizon and benchmark, tell how a portfolio performs.
What Is the Best Online Portfolio Backtest Tool?
The most popular online portfolio backtesting tool is Portfolio Visualizer. It helps predict how a portfolio will perform over a specific time period and given specific conditions.
Portfolio Performance: The Bottom Line
Your portfolio performance relies on many factors, one of which is whether you use an advisor or not. Understand that using an advisor doesn't mean you'll automatically have a positive return. However, an advisor can provide impartial advice and help you create a portfolio with the best chance of meeting your financial goals.