Measuring Portfolio Performance


For many investors, the most important indicator of success is how well they are pursuing their long-term goals. Keeping track of investment performance is an important step in any investment plan. To fairly evaluate your portfolio, you and your financial advisor should determine how your investments have performed in relation to:

1. your specific goals and objectives

2. the general market environment and the specific market environment for the asset classes in which you are invested

3. the performance of other managers/investment objectives

4. the amount of risk taken to pursue the return

When evaluating your portfolio performance, comparing your results against the correct index can give an appropriate benchmark to compare against how your investments are performing. The Dow Jones Industrial Average, which is made up of 30 leading companies, is one of the best-known and widely reported market indexes. Calculated by adding the prices of these 30 stocks and then dividing by the Dow divisor, which changes often, the Dow is typically considered a figure that indicates the general state of the stock market.

With thousands of publicly traded companies, there is more to the stock market than just the “Dow,” however. Although that may sound obvious, we might need to be reminded of this as we take note of the current “soars” and “plummets” of the Dow Jones Industrial Average on a daily and even hourly basis. These shifts are significant, but mostly only for those who are invested in the 30 stocks that make up the Dow. For those investors who hold other stocks, bonds or even cash equivalents, let’s review some of the major indexes from the perspective of investors with diversified portfolios. First, a few basics.

What is an index?

An index is a group of securities designed to replicate the structure and performance of a specific segment of the financial markets. Market indexes are developed and used as comparative measurements for the performance of securities with similar investment style attributes. What all indexes have in common is that the value of the index changes proportionally to the value of the stocks in the index. So when the index goes up, the aggregate (or collective) value of the stocks in the index has grown by a proportional amount, and vice versa.

All indexes measure the performance of the markets or some subsection of them, usually on a continuing basis throughout each trading day. By tracking an index, or a variety of indexes, investors can help gauge market trends that may impact investment decisions. Indexes also function as benchmarks for comparing the performance of the securities investors own against the markets in general. Although most investment managers use indexes as benchmarks, portfolios that are actively managed generally are not restricted to investing only in securities in the index. As a result, your portfolio holdings and perform- ance may vary from the index. The past performance of an index is not indicative of future results and is not a guarantee of how your portfolio will perform. Indexes are not available for investment and reflect an unmanaged universe of securities, which does not take in to account advisory or transaction fees, all of which will reduce the overall return.

What is the dow?

In 1896, Charles Dow compiled a list of 12 large U.S. companies to serve as a general indicator of how well stocks performed each day. The average closing prices of the stocks were posted in a financial bulletin that he published with his partner, Edward Jones. The financial bulletin was the forerun- ner of The Wall Street Journal, and Dow’s list of stocks later evolved in to the Dow Jones Industrial Average (DJIA). Today, the DJIA monitors 30 key industrial companies. It is the Dow Jones Industrial Average that is reported on television, radio and in newspapers during their daily stock reports.

There are also Dow Jones Utility and Transportation Averages, but when we refer to the industry average, it is the DJIA, or Dow, that we are talking about. The Dow is a price-weighted index, which means that component stocks are given relative importance based on the price per share of each stock. Consequently, higher-priced stocks have a greater per- centage impact on the index than lower-priced stocks. If there is a sharp increase in the price of one of the stocks that makes up the Dow, it can push the Dow index to highs while market- capitalization weighted indexes might languish. Because of this, many observers question whether the Dow remains an effective market barometer.