There is only one way to know if you are getting competitive investment performance. You have to select a relevant benchmark and hold your advisor accountable for beating the benchmark’s return. If your advisor consistently outperforms your benchmark you should sleep better at night.
The returns that are produced by your advisor are impacted by the performance of the securities markets. If the markets go down, there is a good chance you will lose money. If the markets go up, there is a good chance you will make money.
Because markets go up and down you cannot hold your advisor accountable for producing a fixed return each year. For example, you want to average a 10% return so you make your advisor accountable for producing a 10% return each and every year. No advisor can deliver consistent returns in a volatile environment. There is a good chance your year-by-year returns will look like this: +15%, -5%, +20%, -10%, and 0%. There is a 30% swing in the returns (-10% to +20%), but you averaged your 10%. What is reasonable is your advisor is accountable for averaging 10% returns over a three or five year time period. This presumes you are willing to take enough risk to achieve the return.
You should require all performance data in a written report so you have a permanent record of what was communicated to you. You do not want verbal information that can be manipulated to make the advisor look better than he really is. When your assets are involved, it pays to remember, “Trust what you see, not what you hear”.
In regard to benchmarks, there are good benchmarks and bad ones. For example, I hear a lot of investors say their goal is to “beat the market”. Their proxy for stock market performance is the S&P 500. This index contains 500 large capitalization U.S. stocks. If your portfolio is 100% invested in large capitalization stocks, then the S&P 500 is a realistic benchmark. However, what if you own bonds and large, medium, and small capitalization stocks. The S&P 500 is no longer a valid benchmark. You need a benchmark that has several asset classes that more closely match the way your assets are actually being invested.
Once you have written requirements, quarterly performance reports, and a valid benchmark you will know the relative performance of your advisor. Use green numbers when your advisor’s performance exceeds the benchmark. Use red numbers when your advisor’s performance lags the benchmark. Let’s hope you see a lot of green numbers.
If you are not inclined to develop your own tools, go to www.InvestorWatchdog.com and use the free tools on the site. There are tools that document your requirements, monitor your performance, and compare your results to Watchdog Benchmarks.