Your relationship with your financial advisor should be a true partnership. Having an advisor doesn’t mean that you’ve handed off your finances and will just be passively accepting the results of your advisor’s choices. Asking questions about your portfolio is part of your role in making this relationship as productive as it can be. As we discussed in a previous piece about financial advisors serving as personal trainers for financial fitness, you still have to show up to your sessions with your trainer willing to do the work – they can’t exercise for you.
Evaluate Early. Evaluate Often.
In a study that Jackson commissioned,1 we found that consumers are waiting for “moments of truth” to evaluate their portfolio’s performance. These moments of truth may include a change in an employment situation, a health-related event or changes in the U.S. economy. Most people tend to evaluate their portfolio as a response to a trigger, rather than as an act of proactive maintenance.
Looking at your portfolio only as a reaction to an event takes the control out of your hands by allowing stimulus to dictate response. By the time you experience a moment of truth, you are more likely to respond based on emotion rather than logic, potentially putting your portfolio at risk. Proactively evaluating your portfolio, based on criteria that matter to you, allows you to be in control when life events occur by anticipating future needs and taking steps to be prepared.
Americans who report being more engaged in financial research and who feel confident discussing financial matters with friends also report higher levels of confidence in their financial plans to support later life.2 Learning how to measure your portfolio’s performance using meaningful benchmarks can be the first step you can take toward gaining this confidence.
Measuring What Matters
Evaluating performance is more complex than just comparing your portfolio to the S&P 500 Index. To have an in-depth discussion with your advisor about performance that honors your particular goals and risk tolerance, it’s essential to understand the following terms and concepts:
Benchmarks are used by advisors and fund managers as standards for evaluating the performance of a portfolio within its investing universe. Several well-known benchmarks used by investors are the S&P 500 Index, the Barclays Capital U.S. Aggregate Bond Index and U.S. one-year Treasury rate. These benchmarks should each be used to evaluate performance within the investing context most relevant to them:
- The S&P 500 Index should be used as a benchmark for U.S. equities.
- The Barclays Capital US Aggregate Bond Index should be used as a benchmark for U.S. bonds.
- The U.S. one-year Treasury Rate should be used as a comparison for liquid savings and cash equivalents.
When discussing performance with your advisor, ask how the investments in your portfolio are performing against the benchmarks relevant to their investment class.
Evaluating Risk Against Reward
To understand how your portfolio is performing, you should be able to evaluate the level of risk you’re taking on relative to the returns. Here are several key terms that are used to evaluate portfolio risk and reward potential:
Risk-Adjusted Return represents how much return your investment has made relative to the amount of risk the investment has taken on over a given period of time. If two or more investments have the same return over a given time period, the one that has the lowest risk will have the better risk-adjusted return.
The Sharpe Ratio is a common measure of risk-adjusted return. It is used to calculate the average return earned in excess of a "risk-free" investment, such as a U.S. government bond. A higher Sharpe Ratio indicates a superior risk-adjusted return.
Standard Deviation is a statistical measure of volatility. A higher standard deviation indicates more volatility and greater risk.
Beta calculates where a stock is on a spectrum of volatility. Think of it as a measure of how closely a stock is correlated with a benchmark, such as the S&P 500, with “1” representing perfect correlation and “0” representing no correlation.
- A beta of “1” means the stock is highly correlated to the S&P 500.
- If a stock has a beta of “0,” it doesn’t necessarily mean that it’s underperforming related to the S&P 500; it just means that it’s not correlated with the S&P 500. So, if the S&P is moving up or down, that is not an indicator that this stock is likely to move up or down, respectively.
- A beta of “-1” means that the stock is inversely correlated with the S&P 500, meaning that if the S&P 500 goes up, this stock is likely to go down.
- A portfolio with a beta of “1.3” is expected to move 130%, up or down, for every change in the benchmark.
- A portfolio with a lower beta would be expected to have less up and down movement than the benchmark.
Correlation is a statistical measure of how two securities move in relation to each other. The correlation of various indexes or securities against one another or against inflation is based upon data over a certain time period and may vary substantially in the future or over different time periods.
Your advisor should be able to answer your questions about how the risk-adjusted return, Sharpe Ratio, standard deviation and beta of your investments align with your overall financial strategy and personal goals. You have a right to demand transparency – if an advisor claims above-average returns on your portfolio, that could also mean above-average risk. Insist that your advisor walk you through how much risk you had to take on to get those returns.
"Your relationship with your financial advisor should be a true partnership... Asking questions about your portfolio is part of your role in making this relationship as productive as it can be."
General Performance vs. Performance for You
While advisors obviously want to get the highest possible returns for the portfolios they manage, they also need to understand what’s most important to you. Choosing an investment strategy is not a one-size-fits-all process. For example, some clients may care more about Environmental, Social, and Governance (ESG) investing than others, and their advisor should be prepared to answer questions about these indicators of success.
Every client is different, and asking your advisor specific questions about your portfolio’s performance provides an opportunity to make your priorities clear. Performance is not just about beating the market on a given day – it’s about aligning with your long-term goals and getting the returns necessary to meet those goals over time.
1 The Journey to Financial Literacy,” Metia Insights, April, 2019.
2 The Journey to Financial Literacy,” Metia Insights, April, 2019.
Investing involves risk and possible loss of principal.
The opinions and forecasts expressed are those of the author and individuals quoted and should not be construed as a recommendation or as complete.