How to Gauge Investment Performance


Year-end statements from banks, brokers and mutual fund companies are packing investors’ mailboxes, or will be any day now. They make it easy to see how your investments did in 2009. But how do you decide whether they did well enough?

Without a clear process for assessing performance, it’s pretty hard to decide whether to keep a holding or trade it in for something better.

Unfortunately, many people shovel money from investment to investment in an endless quest for the biggest possible return. That’s often self-defeating, as many give in to the urge to buy the stock or fund that’s done the best in the past few months, has it’s biggest gains behind it and is ready for a fall.

That’s why studies by Morningstar Inc., (Stock Quote: MORN) show that the average investor, by buying high and selling low, earns far less than fund returns suggest.

The first step in assessing a year’s performance is to reassess your long-term plan. Use an asset-allocation tool to figure your appropriate mix of cash, bonds and stocks.

Assuming your holdings suit your plan, the next step is to assess how they have done. That starts with picking the benchmark, or standard for measuring, appropriate for each holding. If you have a mutual fund with stocks of emerging markets, assess it according to an emerging-markets index, not the Dow Jones Industrial Average, which is full of stocks in big U.S. companies.

Fortunately, mutual fund companies have made this easy by providing benchmark data on their Web sites. If you owned the T. Rowe Price Emerging Markets Stock Fund (Stock Quote: PRMSX), you could look it up on the T. Rowe Price (Stock Quote: TROW) site, click the “Performance” tab and see how the fund did compared to its benchmark, the Lipper Emerging Markets Funds Index.

The Morningstar site also has benchmark data. Most valuable is data comparing a fund’s performance to that of the average fund in its category. The Wasatch Micro Cap Value Fund (Stock Quote: WAMVX), for example, returned 70.4% in 2009, about 33 percentage points higher than the average fund in its Small-Cap Growth category. That made the fund the category’s top performer.

While many investors, if not most, focus on the past year’s results, it’s important to take a longer view in assessing a fund. The Wasatch fund looks like a long-term winner, with $10,000 invested in 2003 growing to nearly $19,000 at the end of 2009, according to Morningstar Data. That gave it an average annual return of 8.02% over the past five years, compared to 5.65% for the funds in the category, putting the fund in first place for the period.

But investors had to endure some scary moments, as the fund produced below-average results in 2007 and 2008.

What if your fund hasn’t done well against its peers? Then you need to find a better one in the same category. Morningstar recommends top picks in each category, and it has a Similar Funds Finder for assembling a list of funds with matching strategies. Both services require a $19.95-per-month premium subscription, but can be used free on a 14-day trial.

Even a diehard buy-and-hold investor is wise to get rid of a holding that consistently trails its peers. But it doesn’t always pay to drop the hammer too quickly. Selling can trigger taxes, and there’s no point doing that if your fund simply fell a nose behind in the past year but has done fine over time.

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