Portfolio returns tell you how well your investment is doing and whether you need to make any changes. It’s important to understand the right away to read your returns; however, if you misread them, you might misunderstand the information they’re giving you. Here are some of the top ways your returns can be misleading.
1. Hidden Fees
When you look at your portfolio returns, it’s important to take hidden fees into account. Often, investors look at the percentage of return without looking at the fees. This can make it seem like you’re getting more back from the return than you really are. Fees are usually calculated as a percentage of your investment; as the returns grow, the fees grow, too. To avoid nasty surprises, make sure you understand exactly what the fees are and how they may impact your overall returns.
2. Benchmark Comparisons
Most statements of return include an “excess return” statement. If you aren’t familiar with this concept, it can be confusing or misleading. The excess return doesn’t tell you how well the return is doing—it tells you how it is doing relative to similar returns. A high excess return is usually a good thing, but don’t get it confused with the actual return you are getting.
3. Inflation Effect
When you look at your portfolio return, make sure you take the amount of inflation into account. Inflation drives up prices and lowers the worth of every dollar. Thus, you need to account for inflation when looking at your return and remove it from the amount you’re getting in order to get the true picture of the return on your investment.
4. Value Ratio vs. Cash Flow
The return on your portfolio is usually calculated by dividing the account’s current balance by the balance from a year ago at this time, then subtracting one. For example, if your portfolio is worth $20,000 now and was worth $10,000 last year, your portfolio would be said to have a 100 percent return. This number is misleading because it doesn’t take into account how much money you put into the portfolio this year. If your balance is higher because you invested additional income, it doesn’t tell you anything about the return on your investment.
Reading your portfolio return may not be as easy as it seems, but once you understand what everything means, you can use it to get an idea of how your investment is doing. Your financial adviser can help you interpret your return or do additional calculations to ensure the return is more accurate.