With 2012 now in the books, it is a great time to undertake an analysis of your financial results.
First, your representative should be able to provide you with the “net-of-fee” performance of your investment portfolio, calculated as a “time-weighted” return. This calculation adjusts for any cash inflows or outflows over the period, including fees.
Some readers may remember the apparently remarkable performance turned in by the Illinois investment club known as the Beardstown Ladies. It later was discovered that the club had counted members’ periodic contributions in its performance calculation.
Second, you should know the amount of fees or commissions you have paid. Here, you may have to pull back the curtain. The financial services industry is adept at making it difficult for investors to ascertain all the fees and expenses they incur in their portfolios. Regulators have tried for years to improve the disclosure of investment costs, but the powerful industry lobby has thwarted most of those attempts.
These two factors—return and cost—drive an investor’s long-term net worth. Net-of-fee performance should compare favorably with a simple chosen benchmark over a period of, say, three years or longer. If you are measuring an equity account, the S&P 500 index is a good benchmark.
If you have, for example, a 30-percent bond and 70-percent stock portfolio, simply add 30 percent of the return of a bond index and 70 percent of the return on the S&P 500 index—keep it simple.
Deviations from the benchmark in any given year should not be alarming as long as the reason for the divergence is sound. Over time, however, your net-of-fee performance should exceed the benchmark. After all, you can invest in index funds and earn the benchmark return at a fraction of the cost the financial services industry will charge.
Personally, I think it’s difficult to justify annual fees in excess of 1 percent to 1.5 percent, unless the long-term net-of-fee performance of the investor’s portfolio well exceeds the portfolio benchmark. Come to think of it, why would any investor willingly remain in an investment program that charges fees if the long-term returns have fallen well short of their chosen index?
Other factors should be considered as well. Some products lock investors into poor investments with substantial exit fees that continue for years. Complex investments also should be avoided.
Time is a major factor in investing. Generally, the longer an investor has to put money to work, the better opportunity to accumulate a significant nest egg. Alternatively, time can exert a negative influence on asset accumulation if performance results are poor and costs are high. Clearly, investors must pay diligent attention to their investment performance and costs.
A year-end review, within the context of a long-term investment program, is a prudent activity to undertake, so that investors are sure they are receiving good results at a reasonable cost. If the investor discovers his long-term performance is substandard and costs are too high, it is time to find a different program.•
Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or email@example.com.