Analyzing Your Portfolio
Investing in the long-term requires you to actively monitor and adjust your portfolio along the way. One of the key skills required for your investment journey is to effectively analyze your portfolio. In this post, we’ll discuss the different types of investments your portfolio may have, which benchmarks to use, and overall portfolio metrics to keep in mind, especially as you get closer to retirement.
Types of Investments
Stocks (Equities)
Investing in stocks means you’re buying a share of ownership in a company. You’re a shareholder, usually with the right to vote on the Board of Directors and issues that affect the company. Some companies reward you by sharing a part of their profits in the form of dividends (a cash payment into your account). Other companies, especially those in their early stages or growth-oriented companies, will choose to reinvest profits into the company to improve/innovate/etc…
A company’s industry, size, and location are very important when deciding how to benchmark that company’s performance. A US-technology firm like Microsoft can’t be compared to a European bank like HSBC, or a Chinese-based oil & gas company like PetroChina.
If you’re looking at a US-based company in your portfolio, you’ll usually want to pick the S&P 500 as a benchmark for larger, well-established companies.
For example, if you own Microsoft shares, you’ll note the share price increased from $86 in 2018 to $239 in 2022, representing an annualized growth rate of 22.7%. Over that same period, the S&P 500’s annualized growth rate was 7.4%. This tells you Microsoft outperformed the market over that period. In addition, Microsoft rewarded you with dividends along the way. If you included those in your calculation, you would be looking at Microsoft’s total return.
If you’re looking at a smaller US-based company, you’ll usually want to pick the Russell 2000 as a benchmark for smaller to mid-sized companies.
For example, if you own Macy’s shares, you’ll note the share price decreased from $26 in 2018 to $21 in 2022, representing an annualized growth rate of -4.3%. However, Macy’s issued dividends along the way. If you include those dividends, your total annualized growth rate would be -0.6%. Over that same period, the Russell 2000’s annualized growth rate was 2.8%. This tells you Macy’s underperformed the market over that period.
Bonds
Purchasing bonds means you’re lending money to a company or a government entity (i.e., city, state, nation). A bond will have a set period (start/end date) and payment schedule of the interest you’ll earn (coupon rate). At the end date, the company or government entity is required to repay you the original loan amount. Bond investments are typically considered more stable than stocks, because they provide steady and predictable income along the way. However, they typically won’t generate the same amount of long-term return as stocks will.
A good benchmark to use for your bonds is the S&P or Barclays US Aggregate Bond Index. During the period of 2018 – 2022, the S&P US Aggregate Bond Index had an annualized growth rate of 0.2%.
Bonds typically fall into four categories:
Corporate investment grade bonds are for companies that are well-established and have a higher credit rating. This means there’s less risk the company will go bankrupt and won’t be able to repay their loans. Just like your personal credit cards or mortgages, the better your credit rating, the lower interest rate you’ll pay. As such, investing in corporate investment grade bonds will generate lower returns than other types of riskier bonds.
During the period of 2018 – 2022, Corporate investment grade bonds averaged 0.8% annually (S&P 500 Bond Index).
Corporate high-yield bonds are for companies that have a lower credit rating, though not low enough to be considered “junk”. This means there’s more risk than investment grade bonds that the company will go bankrupt. However, with more risk comes more reward. The interest you’ll receive along the way will be higher than investment grade bonds.
During the period of 2018 – 2022, Corporate high yield bonds averaged 3.2% annually (S&P 500 High Yield Corporate Bond Index).
Municipal bonds are for government entities that aren’t the US Department of Treasury – typically state, cities, or counties. There are various types of municipal bonds, but the interest payments are generally covered by the taxpayers in that municipality or backed by revenues from a specific project (i.e., highway tolls).
During the period of 2018 – 2022, municipal bonds averaged 1.3% annually (S&P Municipal Bond Index).
US Treasuries are considered the safest types of investments, as they are backed by the US government. These types of investments vary in length (few days to 30 years) and type of interest (i.e., fixed, variable, inflation-protected). The safer the investment, the lower the expected returns. US Treasuries typically generate the lowest returns in the long-term.
During the period of 2018 – 2022, US Treasuries averaged -0.6% annually (S&P US treasury Bond Current 10-Year Index).
Commodities (including Cryptocurrency)
Commodities are raw materials that are either used directly or indirectly to produce another product. The most popular commodities you’d likely consider adding to your portfolio include precious metals (gold, silver, platinum), oil, natural gas, or cryptocurrency. Some other popular ones are corn, wheat, soybeans, cattle, hogs, and lumber, though it’s rare to find these included in a typical long-term investment portfolio.
Generally, commodity investing can be quite volatile and is often heavily impacted by geopolitical events (i.e., Russian-Ukrainian War) and weather (i.e., droughts) to name a few. However, commodities often have low correlation with the overall market which could reduce your portfolio’s risk. Additionally, in an inflationary environment, commodity price growth is expected to match inflation rates.
It’s difficult to establish a benchmark for these assets, as they vary considerably. When reviewing your portfolio as a whole, you should consider how much of your portfolio is exposed to commodities, and what kind of returns you’re expecting from them. A common discussion point with my clients is if a long-term portfolio should include cryptocurrency, and if so, how much of the portfolio should be allocated to it.
Funds - Mutual Funds & Exchange-Traded Funds (ETF)
As you can see from the above, there’s plenty of different types of investments you can make. Mutual funds were created as a “packaged” product for an investor. Instead of buying a few stocks and a few bonds, you can purchase shares of a mutual fund that will do the work for you. These are usually actively managed by a portfolio manager, carry a minimum investment requirement, and typically have an expense ratio of 0.5% to 1.0%, though some may charge much higher fees.
Exchange-traded funds (ETFs) are very similar in the fact that they’re a “packaged” product. Instead of buying hundreds of company stocks, you can buy one ETF share, making it easier for the average investor to diversify their portfolio. These have no minimum investment requirement and typically have a lower expense ratio (0.1% to 0.5%).
When analyzing the funds in your portfolio, it’s important to review the following:
Performance vs. the benchmark set by the fund manager
For example, one of the largest ETFs in the world is the SPDR S&P 500 ETF (Ticker: SPY). As described on the ETF’s factsheet, the main goal of the fund is to provide investment results that correspond to the S&P 500 index. Over the last 5 years, SPY averaged 9.26% growth, while the S&P 500 index generated 9.42% growth.
Expense ratio vs. other similar funds
SPY’s expense ratio is 0.09%, which is very competitive, though that is to be expected given it’s a passive fund that follows an index. Other funds may take a more active investment approach, which could justify higher expense ratios.
Assets under management
The average market cap for SPY is nearly $413 billion, which is very large. Be mindful that a fund with lower market cap/assets under management may not be as liquid as larger ones. This just means when you sell it, there may not be as many buyers and vice versa.
Top holdings
As expected, SPY has over 500 holdings and its largest holdings include Apple, Microsoft, Amazon, Google, Johnson & Johnson, Exxon, … This is to be expected because the fund’s goal is to replicate the overall market’s return, which is largely driven by these big-name firms. Be mindful of funds that are heavily weighted towards a single or small set of companies, as that increases your risks.
ESG rating
ESG stands for Environmental, Social and Governance. Firms are evaluated by independent research companies to determine the risks associated with global climate change, diversity, and inclusion, geographical or political involvement, … A good tool to use is the MSCI ESG Fund Ratings and Climate Search Tool. Because SPY is trying to replicate the S&P 500 index returns, it’ll be exposed to companies that could be associated with severe controversies, involved in the weapons & tobacco industries, and traditional oil & gas companies. Note that there are alternative ETFs that follow the same index but remove some of these poorly graded firms. As such, they provide the investor with similar, if not better, market returns, while knowing they’re not invested in companies that do harm.
Key Metrics
Now that you’ve learned how to analyze the different types of investments in your portfolio, it’s important to look at the overall performance of your portfolio. Because calculating these metrics requires quite a bit of math, it’s often easier to use an online tool to do the work for you. I like the “Backtest Portfolio Asset Allocation” tool by Portfolio Visualizer. All you need to do is enter the different investments you have and the weight it represents in your portfolio.
Standard Deviation
This metric calculates the volatility of your portfolio. A younger investor that is willing to take on a bit more risk would likely want a portfolio with higher standard deviation. An older investor that’s getting closer to retirement would likely want a lower standard deviation.
World stocks typically average a standard deviation of 20%, while world bonds typically average a standard deviation of 8%.
Beta
This metric is very similar to the standard deviation, but it compares it to the S&P 500, which gives you a more accurate reflection of how you can expect your portfolio to perform compared to the overall market.
A portfolio with a beta of 1.0 would be perfectly correlated with the market. A portfolio with a beta of 0.8 would be slightly more conservative, while a portfolio with a beta of 1.2 would be more aggressive.
Sharpe Ratio
This metric is meant to compare the return of your investments compared to an investment that has no risk (i.e., US Treasuries). In other words, had you put all your investments in US Treasuries, did your portfolio outperform? If so, by how much?
Typically, a Sharpe ratio that ranges from 1.0 to 2.0 is good, and anything above 3.0 is excellent.
Upside/Downside Capture
This is one of my favorite metrics. An upside capture is meant to indicate how your portfolio performed during periods of positive returns for the benchmark.
An upside capture ratio above 100 would tell me the portfolio outperformed the market during periods of positive returns, likely attributed to a more aggressive portfolio. An upside capture ratio below 100 would typically indicate a more conservative portfolio.
Especially important for older investors, the downside capture metric indicates how your portfolio performed during periods of negative returns for the benchmark.
A downside capture ratio below 100 would tell me the portfolio didn’t fall as much as the benchmark in periods of negative returns, indicating a more conservative portfolio. A downside capture ratio above 100 would indicate a more aggressive portfolio.
Closing Thoughts
Analyzing your portfolio is an important step throughout your investment journey. This is an unbiased view of your portfolio’s performance and educates you on where adjustments should be made. These metrics can understandably be confusing to investors, so don’t underestimate the value of an investment adviser when reviewing and executing your investment strategy.
