Most of us think that we are above average drivers. Likewise, I have never heard anyone say they are bad at investing. After experiencing negative returns, the market is to blame or maybe the President of the United States is to at fault if they belong to the “wrong” political party. After positive returns, I only hear about how great the person is at picking stocks. Here’s the thing: most people don’t actually know how their investments are performing.
I have yet to see a brokerage statement that showed meaningful information. The typical statement has something like this on one of the first pages:
Month starting balance
Month ending Balance
The following pages don’t give much more information – usually a list of positions and transactions – so you can see if you had more or less than you started with last month, but how does that compare to the market, the investor’s expected returns, or the investor’s benchmark? What if the investor’s time horizon is (gasp) greater than one month? How has the account performed over 1, 3, 5 years? What about the portfolio as a whole? How do the individual investments stack up against appropriate benchmarks? How did cash flows impact performance? What fees are being paid?
“I know a guy who picks his own stocks and he makes money.” That’s not nearly enough information to judge whether a person is good at this or not. You can get a good idea of performance using just Excel and some formulas, but most people don’t have the time or inclination to do this. Instead, they look at the monthly balance on their statement to get a gut feeling of whether they did well or not. Someone who’s serious about investing will have sophisticated portfolio performance tracking software. These people will be able to see not only how they did over multiple time periods, but how that compares to meaningful benchmarks.
When investors are denied access to meaningful return information, it is easier for the broker to sell product and obfuscate actual performance. I’ve seen statements where a broker would just constantly buy the top performers from the previous 12 months. This made him look like a genius, but the client didn’t actually experience those returns. In fact, the client was buying high, often right before mean reversion brought those securities crashing down to earth. There was no way for the client to know, though, unless they put in the time and effort to track the real performance and isn’t that what they were paying the broker to do? A broker is not a fiduciary and doesn’t owe investors jack (except a low “suitability” hurdle).
In addition to raw performance numbers, investors need to know the costs associated with the portfolio including fees to the advisor and expense ratios for mutual funds, ETFs, and any other investments. Yet another factor not accounted for on the vast majority of brokerage statements is taxes. All the outperformance in the world is worthless if it’s just going to Uncle Sam and not the investor.
Performance reporting is decidedly un-sexy. Nobody asks what reporting software you’re using while making small talk at a cocktail party. CNBC is not asking the guys with slicked back hair or pony-tails about time-weighted returns or benchmarking. However, you will never know if you’re really doing well or if your stock picker really knows his stuff without a true measure of returns.