Are Performance Reports Important?

investors are or soon will be receiving the year-end Performance Reports for their investment accounts.  Before looking at this or any Performance Report, investors should ask themselves are they important and if so why?  What is the value of a quarterly or year-end performance report?

Before going farther, consider this example.  There are three investors who invest in three different stocks, ABC Co, DEF Co, and GHI Co.  Each invests $10,000 in one of the stocks.  At purchase, each stock is trading at $10 per share and each investor buys 1,000 shares of the stock.  At the end of the same five-year time period, each investor sells the shares of the stock.  During the five year time period:

• ABC stock gradually increases from $10 per share to $15 per share over the five year time period at which time the investor sells the stock at the end of five years.
• DEF stock decreases over the first two years to $5 per share, over the next two years, the stock recovers to $10 per share and by the fifth year increases to $15 per share at which time it is sold by the investor.
• GHI stock increases to $20 per share over the first three years, then decline to $15 per share the next two years at which it is sold at the end of the fifth year.

Which investor had the highest return on the stock they owned?  Obviously, they all had the same return in that they each paid $10 per share and five years later sold for $15 per share.  Given this, what was the value the Performance Reports each investor received quarterly until the stock was sold at the end of the fifth year?  

Before going farther, it is important to understand what a Performance Report does not do. 

• A Performance Report does not tell an investor the actual or realized gain or loss on a specific holding or the portfolio.  The only time an investor knows the return on an investment holding or the entire portfolio is when it is sold or liquidated.  
• A Performance Report does not predict the future.  In fact, most if not all Performance Reports have a disclaimer that states the Report does not predict the future.  

What the performance report may tell you is the following:

• The market value of the portfolio as of the date of the report.
• The increase or decrease in market value of the holdings and overall portfolio during the reporting time period.  Most often this is the previous quarter or calendar year.  
• The current allocation of the portfolio.  Often this is broken down into cash or money market, bonds and equity.  
• Some reports list the actual net investment into each holding and the overall portfolio.  These reports often also this the gain or loss since inception as of the date of the report.  

Of the above, personally, I find the increase or decrease in market value the account in general or specific holdings irrelevant.  The reason is the return does not predict the future nor does it tell an investor what the gain or loss of a holding or the total account will be when it is sold.  Market values, especially during certain time periods, can change so quickly for a variety of reasons.   For this reason, the gain or loss over a specified time period has, in my estimation, no real value.  

What does have relevance in my estimation?

The current allocation.  This will help tell an investor the volatility risk in the portfolio.  For example, a portfolio, which has an allocation of 60% bonds and 40% equity, has significantly less volatility risk than a portfolio, which are 20% bonds and 80% equities.  If an investor does not like volatility, then an allocation which is conservative or moderate will have, at least theoretically, less volatility and likely be more attractive than an aggressive allocation.  Of course, again at least theoretically, an aggressive allocation has a higher potential return. 

If the report lists the net contributions for each holding along with gain or decline since inception for the holding, I find this valuable for several reasons.  Each holding may be reviewed with the following objectives.  

• If there is a substantial gain in a holding, it's a good time to discuss valuations, the holding's overall asset class, the initial time horizon and return objectives, and finally the upside potential going forward.
• If there is a substantial loss, do the same as if there is a gain but keep the following in mind.  Too often investors see a decline in a holding, make the decision to sell, and turns a paper unrealized loss into a realized actual loss.  This may be an emotional response to temporary market value.  If the investment later recoveries and reaches the initial target price within the original time horizon, because of a rash uninformed decision, rather then having the potential for selling for a gain, the investor has already locked in a loss.  In many cases, the investor would have increased overall gain by adding to the position during the decline by lowering the overall cost basis during the decline.  

In summary, in my estimation, a quarterly or year-end performance report has no value in terms of evaluating or predicting return.  It does have value in reviewing the current allocation along with existing unrealized gain or loss of holdings.

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.