Evaluating Investment Performance

Evaluating Investment Performance

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There has recently been a lot of negativity directed towards the mutual fund and financial advisory industries around performance and fees, partly because of the emergence of Exchange Traded Funds (ETFs) with lower fees. Advisors however rely on mutual fund fees. Clearly my bias is towards taking full control with direct stock ownership. This virtually eliminates fees and if done correctly can enhance performance. It isn’t nearly as difficult as it’s made out to be. However, this isn’t the solution for everyone and many will continue to rely on advisors.

A friend contacted me wondering if I would give him a second opinion on his mutual fund portfolio. He too was concerned about performance and fees. I was hesitant as I am not licensed to provide advice catered to an individual. My work is categorized as “Advising Generally,” which allows writing and speaking to a broad audience. I suggested however comparing his performance to ours to help him evaluate.

My friend’s portfolio performance chart included annual results from 2010 to 2018. Canadian and International balanced funds, which contain both equities and bonds, represented the bulk of the assets. He was thus widely diversified with slightly more equity than bonds. His compound annual growth rate (CAGR) was 5.4% for the nine years. From what I understand, this would be average performance amongst investors. (All calculations were done to present as simple and fair a picture as possible)

To get a broad comparison, I averaged four personal accounts, our two RRSPs and two TFSAs. The CAGR of these accounts calculated to 9.9%. The average of the Canadian and US equity (S&P 500) indexes CAGR was 8.5%. One would certainly expect lower performance from a balanced portfolio than an all equity portfolio, as in theory a balanced portfolio gives up performance but protects the downside in weak years. Did this happen?

The comparison was illuminating to me. I previously believed the theory, but argued that an all equity portfolio performed so much better long-term, especially at today’s interest rates, that it is best to go all equity. This is dependent on a person’s situation, needs and time-runway, but most would benefit from all equities while accepting greater volatility. However, in my friend’s case the balanced approach DIDN’T protect the downside.

In three out of the nine years, equity markets were down. In two out of those three down years, our all equity portfolios outperformed his balanced portfolio. On average, over the three down years, my friend was down 3.2%, whereas my wife and I were down just 1.8%. The equity indexes were negative 4.5%. You could argue he did slightly better than the equity indexes but at what cost?

There were six strong equity years during which my friend averaged a gain of 10.0%, but my wife and I gained 16.4%. The equity markets averaged a gain of 15.7%. Giving up six percent on good years was a huge cost for the questionable downside protection achieved during the poor years.

Perhaps none of the three down years were severe enough to show the true value of a balanced approach. I went to the fund websites and found 2008 in their long-term charts. This was the worst equity year in over 75 years, so a true acid test. On average the balanced funds were down 24.6% whereas our personal all equity RRSPs (TFSAs didn’t exist then) were down 22.5%. The markets were off 35.0%. My equity approach has done comparatively well in difficult years, but is not guaranteed.

I used the “Rule of 72” to calculate the effect of the performance differences. In a 35-year time-frame, my friend would turn $1,000 into $6,400, equity market returns would be $17,600 and my results would be $28,800.

Many will continue to buy mutual funds through financial advisors, which may be best for those who appreciate personal advice and financial discipline. My biggest encouragement is to become educated enough to evaluate performance to help you determine value for fees, which could be two percent annually. It doesn’t have to be an all or nothing. You can work with an advisor on some accounts and on your own for others.

During a 35+ year career in agriculture, Herman VanGenderen became an active investor in stocks and real estate. He writes a monthly newsletter and his book “Stocks for Fun and Profit: Adventures of an Amateur Investor” is available at internet book sites. Visit his website at www.you1stenterprises.com, or email comments and questions to you1st.stocks@gmail.com.