Tax Season

Why your portfolio may not be as healthy as you think

Most investors don't know whether their investments are underperforming or not, but there are ways to figure out how your portfolio is really doing.

Quarterly statements rarely tell the whole story

You can scan your quarterly statements for mention of your personal rate of return, but you may not find it. Many investment advisers and firms don't routinely provide it. (iStock)

You've just received the quarterly statement from your mutual fund company or financial adviser, and the results seem good. Your portfolio's worth has grown by five per cent from the last quarter and by 15 per cent over the past year —in fact, you see that your portfolio has doubled in the past five years.

Wow, you think, my financial adviser is a genius!

Not so fast.

Chances are that the figures you've been provided with show the overall value of your investment holdings. The catch is that most statements don't clearly show how that figure has been inflated by your regular contributions and perhaps by regular deposits of interest.

In other words, that seemingly glowing return on your investments could be due in large part to the additional contributions you've made, not to growth of the investments themselves.

Warren MacKenzie, founder of Toronto-based Weigh House Investor Services, says that when he worked at a big mutual fund company 20 years ago, he suggested they provide clients with calculations of their personal rate of return rather than the overall growth of their portfolio.

"'Great idea,'" they said. 'We'll get right on it.'"

Twenty years later, he's still waiting.

Common error

To figure out the real performance of your portfolio, you have to account for all those deposits (and any withdrawals). Failing to do that will leave you with a wildly inaccurate picture of how your investment portfolio has been doing.

It sounds simple, but it's surprising how often this factor is overlooked.

Back in the 1990s, a group of women investors from Beardstown, Ill., realized they'd made this mistake – but not before they'd written a best-selling book about how their small investors club had beaten the stock market and produced an annualized return of 23.4 per cent over 10 years. The book crowed about how their approach to investing delivered results that far surpassed what most professional money managers had been able to achieve.

The only trouble was, they had forgotten to account for those cash inflows into their club. The investment growth of their portfolio over those 10 years was actually just 9.1 per cent annually — six percentage points lower than what the broad market had returned.

Embarrassing doesn't begin to describe the fallout. Their well-meaning but hopelessly inaccurate bestseller — The Beardstown Ladies Common-Sense Investment Guide: How We Beat the Market and How You Can Too — was pulled from store shelves just as the lawsuits began to fly. 

Rate of return

So, how do you avoid the Beardstown fiasco and figure out how you're really doing financially?

What you need to calculate is your own internal rate of return (IRR) — also known as the personal rate of return or the dollar-weighted rate of return.

What you need to calculate is your own internal rate of return (IRR) — also known as the personal rate of return or the dollar-weighted rate of return.

You can scan your quarterly statements for a mention of this figure, but you may not find it. Many advisers and firms don't routinely provide it.

Why not?

Well, that would make it easier to compare just how well your portfolio has done relative to an appropriate benchmark, such as the average return of the markets. Some advisers, it seems, don't want their clients to know the ugly truth that they aren't adding much, if any, value for the fees they charge.  

MacKenzie has witnessed first-hand how reluctant some advisers are to reveal how well (or poorly) their clients are actually faring compared to the benchmark.

"One woman who came to see us said her adviser told her that [calculating her benchmark] couldn't be done because she had both stocks and bonds," he said.

The bottom line quickly became clearer, said MacKenzie, when his own calculations showed the adviser had badly underperformed the benchmark.

"I think he's afraid he'll lose the account if he comes clean," MacKenzie said.

Figuring it out

Figuring out one's personal rate of return in a portfolio is not the easiest calculation to perform, especially for the mathematically challenged. MacKenzie's firm has an online calculator that will do the figuring for you.

"It's the best one I've seen on the web that's free," says Justin Bender, a portfolio manager at PWL Capital, a fee-based investment management firm.

Bender cautions that large contributions made just before periods of relatively good or poor performance can skew the results. But for most investors, he says, the Weigh House calculator works well.

"A lot of advisers like to pretend that active management is paying off," says Bender.

The calculator can reveal the truth — that most advisers don't outperform benchmarks over the long term.

Besides its rate of return calculator, Weigh House also has calculators that can figure out if your portfolio's performance is falling short of the appropriate benchmark. One has users spell out their asset mix and compares that with appropriate benchmarks, so if their portfolio is 50 per cent equities and 50 per cent fixed income, they won't be comparing returns to an all-equity benchmark.

A third calculator tells you how much underperformance can cost you over time. Seeing how relatively small changes in the rate of return can have a huge impact on how much money you'll have in your golden years is sobering stuff, and it leads you to wonder why there isn't a requirement to routinely disclose this information.

Adviser fees don't always translate into profits

FAIR Canada — the Canadian Foundation for Advancement of Investor Rights — supports moves to have the industry provide better performance information to investors.

"Performance reporting has not been particularly uniform," says the group's executive director, Ermanno Pascutto, noting that sometimes such reporting is non-existent.

"Many investors find after 10 years that they're no further ahead than when they started, but the financial adviser has generated large fees."

That makes it even more critical,  he says, that investors be given easy-to-understand information about how their portfolio has been doing so they can see whether their advisers have been earning those fees. 

Still, some firms are coming through. BMO InvestorLine and RBC Direct Investing are two discount brokerage firms that routinely provide their do-it-yourself clients with personal rate of return calculations. Investment counsellors often do this for their high-net-worth clients. But many other firms that actively manage money don't routinely do this, nor do most financial planners.

What should you do if your adviser says he or she can't — or won't — provide this calculation for you?

"Find a new adviser," says MacKenzie. "In most cases, they won't volunteer it. But in most cases, if you ask, you can get it."