5 Ways to measure investment performance

In this post, I focus on five investment performance metrics which are long-term in nature and which could help you avoid the perils of a short-term mindset.

Why you should be a long-term investor

Most investors know you shouldn’t invest in the stock market if you’re likely to need the money back within five years.

That’s because in the short-term (periods of less than five years) the stock market is like a casino. Your short-term returns are driven primarily by the random ups and downs of the market and you’re about as likely to lose money as you are to gain it.

But in the long term, thanks to inflation and real economic growth, companies tend to get bigger and the stock market goes up.

The market will still follow an almost random walk, but in the long run, the random ups and downs cancel each other out and you are left with something close to the underlying economic growth.

This is very similar to property investing. If you buy a house today and sell it next month or even next year there’s a very good chance you’ll lose money. But if you buy today and sell in a decade, the odds of a successful outcome are immeasurably higher.

So sensible investing is long-term investing.

But for most people, it’s all too easy to focus on the excitement and fear of daily share price fluctuations rather than the infrequent drip of company annual reports.

What we humans need is something to focus our attention on our important long-term investment goals and away from irrelevant short-term volatility.

Use long-term performance metrics

One solution is to use performance metrics which are almost exclusively focused on the long term.

For example, the UK Value Investor model portfolio has three goals and five core performance metrics:

  • Goal 1: Above-average growth
    • Metric 1: Beat the FTSE All-Share over five years
    • Metric 2: Grow from £50k to £1m within 30 years (requires an annual return of at least 10% per year)
  • Goal 2: Above-average income
    • Metric 3: Have a higher dividend yield than the FTSE All-Share
  • Goal 3: Below-average risk
    • Metric 4: Suffer a smaller maximum decline than the All-Share over five years
    • Metric 5: Produce a positive capital gain over five years

With the exception of dividend yield, all of those investment performance metrics are focused on the longer-term, five-year-plus time horizon.

As a result, I don’t track the portfolio’s performance over the last month, quarter or even the last year. Such short-time horizons should be completely irrelevant to the long-term investor.

Let’s have a look at some of those performance metrics in detail so you can get an idea of how they work in the real world.

#1: Beat the FTSE All-Share over five years

Beating the FTSE All-Share over five years means beating it on a total return (i.e. capital gains plus dividend income) basis.

For the traditionalists, here’s the standard “value over time” view of the model portfolio versus its arch enemy, the Vanguard FTSE All-Share tracker:

Value Investing Portfolio Performance 2018 07
Past performance is only a weak guide to future performance

As you can see, the model portfolio has beaten the market. Hooray for me.

The problem with this chart and this way of looking at performance is that it highlights all the irrelevant share price noise.

For example, you might look at the 2014-2016 period when the All-Share’s price declined and say:

“Oh dear, look at how risky that is. If I’d bought in 2014 and sold in 2016 I would have lost money.”

That would be true, but it would also be a really bad way to think about investing.

That would be like buying a house for £500k and then for no good reason selling it to Dave down the pub a year later for £250k, just because Dave tells you that’s what it’s worth.

Yes you would have lost money on the house, but that doesn’t mean the house was a risky investment. It just means you made a very bad sell decision.

So the daily, weekly, monthly and even yearly ups and downs in price (not intrinsic value, which is a very different thing) are a distraction and should, for the most part, be ignored.

Of course, in the real world that’s going to be impossible. But we can at least focus on the long-term more and the short-term less.

How so?

Take a look at this chart. It shows the same investments, but this time it just their total returns over five years:

Value investing portfolio five-year returns 2018 07
Five-year returns are much more consistent than one-year returns

For example, the All-Share’s five-year total return to May 2016 (i.e. from May 2011) was about 25% and its five-year total return to July 2018 (i.e. from July 2013) was about 50%.

As you can see, the FTSE All-Share’s five-year return over the last few years has always been positive (because we’ve been in a bull market since 2009), with an average five-year return of 52%.

The model portfolio’s five-year total return was always slightly higher, with an average five-year return of 77%.

For most people, if you asked them if they’d like to invest and get between 52% and 77% over five years, they’d bite your hand off.

But most people don’t think of it like that.

Instead, they think about the fact that the market went down between 2014 and 2016 and they think about the risk of losing money.

And that fear stops them from getting a 50% or higher return over five years.

And while your five-year return will vary over time, it won’t vary anything like as much as your returns over one year, and that means it should be less stressful to periodically review.

So if you track your portfolio’s performance I suggest this:

  • Start tracking investment returns over five years
  • Make that your primary measure of returns
  • If you’re brave, stop tracking returns over one year or less

#2: Grow from £50k to £1m within 30 years

Five-year goals are nice, but I think it’s important to have very long-term investment goals as well.

For example:

  • Accumulation phase: Build a portfolio of shares which can generate a £20,000 dividend income.
  • Income phase: Grow your dividend income ahead of inflation for the rest of your life.

Either way, a multi-decade goal can be useful if it inspires you to save harder or invest wiser.

For the model portfolio, the long-term goal is to grow from £50,000 to £1 million within thirty years (with a start date of March 2011).

It’s still early days, but here’s the progress so far:

Million pound portfolio 2018 07
After the first doubling the model portfolio is almost a quarter of the way to a million pounds

What I like about the Millionometer is that each milestone is double the previous one.

This makes sense because investing is all about exponential returns, not linear returns.

So if your rate of return is the same, it will take you the same amount of time to go from £400k to £800k as it took you to go from £50k to £100k, despite the increase being eight-times larger in Sterling terms.

That is the magic of compound interest (as shown by Monevator’s handy compound interest calculator).

So after seven years the model portfolio has more or less doubled in value. At that rate it’ll hit £200k in 2025, £400k in 2032 and £800k in 2039.

That will be just before its 30th anniversary in 2041, so the portfolio is more or less on target to reach it’s very long-term million pound goal.

Some key takeaways:

  • A five-year time horizon is a good minimum, but your real focus should probably be on getting good returns over the next few decades
  • Have a very long-term goal that inspires you to save hard and invest wisely (a phrase borrowed from the excellent Retirement Investing Today blog)
  • Don’t bet the farm! As management guru Jim Collins once said, “if you get four tails in a row and you know that eventually you’re going to get heads again, it doesn’t matter if you get killed on tail number four.”

#3: Have a higher dividend yield than the FTSE All-Share

Okay, this one’s a bit simpler.

The model portfolio is designed to be of interest to both growth and income-focused investors, so it needs to always have a higher dividend yield than the FTSE All-Share.

This is obviously a very common metric and is easy to measure, so here’s a chart showing dividend yield since 2013 (the portfolio started in 2011 but was only partially invested for the first year or so, and dividends from that early period are unrepresentative):

Value investing portfolio dividend yield 2018 07
The model portfolio’s yield has been consistently above average, but the gap is narrowing

I think there are two interesting features of this chart:

  1. The FTSE All-Share’s yield is still above 3%, despite the long bull market we’ve been in
  2. The gap between the model portfolio’s yield and the All-Share’s yield has shrunk, a lot

On the second point, the underlying investment strategy (Defensive Value Investing) was more focused on value than quality in the early days. As a result it selected more high yield investments.

Over the years I’ve updated the strategy and it’s now more balanced between value companies and quality companies, and of course the quality companies tend to cost more and have lower dividend yields (because of expectations of higher dividend growth).

If the model portfolio’s yield does drop below the All-Share’s yield then I’ll have make some adjustments.

That will mean offloading some of the more expensive lower yield holdings and replacing them with higher yield stocks.

But if I do that it will still be done slowly and steadily, at my usual pace of one buy or sell trade each month.

To finish off the topic of yield, here’s what the actual dividend payments look like for the model portfolio and its benchmark:

Value Investing Portfolio Dividends 2018 07
Dividends going in the right direction

#4: Suffer a smaller maximum decline than the All-Share over five years

Although most of the time you should ignore share price volatility, in the real world that’s likely to be impossible (when the market declines by 50% it’s pretty hard to ignore).

One way to cheer yourself up when the market’s crashing is to be able to say:

“My portfolio may be down, but not as much as everyone else’s!”

In this case “everyone else” is the market and all of the passive index trackers that follow it.

To be honest that isn’t very comforting when you’re down by 25%, but along with a long-term focus (“I’m down 25% this year but up 50% over the last five years, and that’s what matters”) it could be enough to stop you panic selling at precisely the wrong moment.

This is also easy to track.

All you need to do is note your portfolio value each month (or whatever frequency suits) and keep a note of its all-time high value. After that it’s easy to calculate where you are today relative to that all-time high.

Do the same for the FTSE All-Share and hey presto, you can compare the size of your decline.

For example, over the last five years:

  • The model portfolio’s biggest decline from a previous high was 4.4%. That isn’t even a “correction”, to use the stock market lingo.
  • The FTSE All-Share’s biggest decline was 11.4% between 2014 and 2016, which would be classified as a small “correction”.

Neither of those declines is particularly scary, but this metric will definitely come in handy when the declines are bigger (although still temporary when you take a long-term view).

I don’t have a chart of maximum declines as it doesn’t change very much. Instead, here’s a chart showing all declines for the model portfolio and FTSE All-Share from previous highs:

Value investing portfolio declines 2018 07
Having smaller declines than the market is not an exciting goal, but it keeps risk in check

My tip for coping with market declines:

  • If you don’t like to see your portfolio fall in value, try to invest in a diverse portfolio of quality companies at attractive prices
  • Compare your declines against the market and celebrate if your declines are smaller
  • Think about your positive returns over the last five years and not just your negative returns of the short-term past

#5: Produce a positive capital gain over five years

The idea behind this metric is that most people hate the idea of losing money in the stock market. They think if a share’s price falls below their purchase price they’ve “lost money”.

And if their shares fall a lot, many of them will panic sell to avoid further “pain”.

This is a really bad way to invest. Let’s go back to the example of your house and Dave down the pub:

If you purchased your house for £500k and the next day Dave down the pub says he’ll buy it from you for £250k, have you lost any money?

The answer is obviously no, as long as you ignore Dave and his ridiculous offer.

And in most cases investors are free to ignore the market when it marks down a company’s shares.

Unfortunately though, most investors are simply unable to ignore the market’s opinion.

That’s where this goal of producing positive five-year returns comes in.

In effect, aiming at always-positive five-year returns means you’ll be able to say:

“Okay, my portfolio was worth £100k last week and this week it’s down to £80k. I could sell now to avoid further losses, but I’m pretty sure that in five years it will be higher than £100k. And in all likelihood it will be much higher. So this decline is a temporary blip and is nothing to worry about.”

Obviously you’d need to back up those words with an investment strategy that is likely to deliver the goods, but I think it’s a powerful mindset.

I’m sure it won’t stop people panic selling at the bottom of bear markets, but it’s a step in the right direction.

As for how the model portfolio has done relative to this goal, its five year returns have been consistently positive thanks to the post-2009 bull market.

The real test will of course come when we enter the next major bear market.

So, if you have a tendency to panic when the market or your investments suffer price falls, try this:

  • Focus on where your portfolio will be in five years
  • Think about the positive returns you expect to get over the next five years
  • Think about how much your portfolio has grown over the last five years
  • Remember that the share price of each company is simply someone else’s opinion
  • Stick with an investment strategy that focuses on above average companies at below average prices

Congratulations for making it to the end of this Very Long Blog Post. If you have any unusual performance metrics of your own then please share them in the comments below.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

14 thoughts on “5 Ways to measure investment performance”

  1. I used to have the dividend yield target of your portfolio but now I think that if a company reinvests the dividends and does a good job of growing the investment I would rather they had the money than I did. I can always sell a little when I want if I need income, although I agree that this strategy relies on low transaction costs. Some discount brokerages charge as little as £5 for a trade so this strategy is possible without it being too much of a drag on the returns. It is probably outweighed by not being restricted to investing in companies with an above average dividend yield.

    1. Hi Andrew, I agree. If a company can generate above average returns (> 10% or so) on reinvested profits then it should reinvest them rather than pay them out as a dividend.

      And you’re right that selling shares isn’t especially expensive if the trade is big enough (several hundred pounds at least I’d say).

      For me the high yield goal is mostly about a) getting a reasonable income with very little hassle (i.e. having to sell shares) and b) having a sanity check on the portfolio’s overall valuation (i.e. if the yield is above average then it’s very unlikely that the portfolio is overvalued).

      As for being restricted to companies with an above average yield, you can get around that by having a mix. For example, some of the model portfolio’s holdings are quite low yield, as low as 2% or so. But that’s offset by other holdings which have yields well in excess of 5%.

      But you’re right, it can be a little restrictive but perhaps that’s a good thing (like a car seatbelt).

  2. Hi John,

    You make a valid argument for taking the long view. However, this is only possible in mature industries. The only issue is then to buy in industries which have sufficient pricing power earn returns that beat both the discount rate and inflation rate.

    Unfortunately, companies of such nature are rarely priced reasonably most are overvalued. Coca-Cola stock is a prime example within 20-year span investors made little return. Despite the fact, that the company itself was profitable This acts as a reminder that you also need to buy the investment at a fair price.

    1. Hi Reg, that is indeed the central problem. As you say, long-term investors should be looking for mature companies with multi-decade histories of success, and of course they’re typically large, well-known and extensively researched by analysts. Therefore they’re rarely “cheap”, and if they are there’s usually a good reason!

      On the flip-side, the challenge is what makes it interesting.

  3. Hi John,

    Thanks for an interesting post. I started investing in AIM companies with good success but felt it was too risky to invest significant sums. I then switched to FTSE 250 companies but got burned by Aberdeen Asset Management underperforming. It wasn’t major but again made me wary of investing significant sums in individual companies. I then switched to investing solely in Vanguard’s UK total return tracker VUKE.

    Since 2015 I’ve been getting a compounded return of 11% (7% index return, 4% dividend). I’m very happy with this and I am also happy to have a much bigger amount invested for the long term in the stock market. As I work, I haven’t got time to look into individual companies, I need a set and forget strategy that I can leave to work in the long term. I’m also trying to get to £1m before I retire, a nice round target, but I’m adding money so will hopefully get there within 15 years.

    A good book about long term returns is Stocks for the Long Run by Jeremy Siegel. There are loads of stock market statistics showing why people should invest in stocks but my favourite is that if you invest for a period of over 17 years since 1900 the chances of losing money are zero! The shorter your investing horizon the higher the chance of losing money, as you said above. But there have been many periods where no return has been made over a 17 year period. I believe that the next 17 years will be good to us though.

    1. You mention that “there have been many periods where no return has been made over a 17 year period” I think this entirely depends on what you invested in the first place. The performance of VUKE seems amazing however I have my reservations for the following reasons:

      1) HSBC, Royal Dutch Shell and BP heavily appear in the portfolio of VUKE. My only concern is that due to the cyclical nature of these companies will they be able to continuously pump out the dividends in the future? This is probably one of the reasons why they are included in the fund in the first place.

      2) Another issue for concern is index return if you look at total return for companies like HSBC, Royal Dutch Shell and BP they haven’t increased substantially over 18 years (some may have even declined if you factor in inflation). Therefore the question is can the above stocks, which contributes to 20% of the portfolio act as a drag to the performance of the fund over the long term?

      1. Hi Reg,

        When I referred to 17 years of no return I was talking about indices, the FTSE 100 and Dow Jones Industrial index specifically. Yes there will be big companies like HSBC, Shell, Vodafone, Unilever etc that act as a drag, but these are the companies that underpin the dividend of the FTSE 100. They also have mature assets and are able to raise prices to counter inflation. Then there will be new stars like Vodafone was in 1988 when it was listed as Racal Telecom. In my opinion the cream will rise to the top so I am happy for VUKE to grow as the economy grows.

        I realise that this blog is about investing in individual shares and I’m not trying to convert anyone, I’m just noting that indices move in large cycles and a new secular bull market will lift all boats. If you can spot the stars like Fevertree and ride them, then even better. That is just not for me. Buying an index is easy and better than not investing at all.



      2. Hi Kerry,

        I have a bias to dividend stock so we speak from the same page. As dividend are responsible for something like 42% of the return for the market.

        I also agree with your point that “Buying an index is easy and better than not investing at all” since if we leave the cash in the account over a 20 year period (if the inflation rate is 2.5%) the value of your cash will drop by 38.19%! So yep in this regards index is definitely a means to preserve your cash value.

        All the best


      3. Hi Reg, this ties into my previous comment about stocks, cash and risk. If risk is defined as getting a low return (possibly below inflation) then in the long-term cash is riskier than stocks. If only more people would see is that way then perhaps we wouldn’t have such a big savings crisis.

    2. Hi Kerry, on the 17-year thing, it’s true and is hard for people to accept that over the long-term equities are less ‘risky’ than cash, if by risk you mean achieving a reasonable (perhaps > 5%) annualised return. But people think of risk as how much prices go up and down so they think stocks are risky.

      As for the next 17 years, I agree; I think the odds are that the next 17 years will be much better for UK stocks than the last 17 as we’re not starting from daft valuations and tiny yields.

  4. There is a massive difference between a notional paper portfolio and the real world stock market. It is easy to count up the “doublings” but the real behaviour of the markets also involve a number of “halvings” from time to time and sometimes extended periods of bleeding. We have not had anything like that since 2009 but it will happen again. Very few people have the intestinal fortitude to withstand those episodes where you see your net worth dropping by six figures or more in a few months. That is why few real world investors get the long term market return and are unlikely to manage the trajectory from £50K to £1m without getting shaken out at some stage – it is human nature.

    1. Hi Lemsip, I completely agree and that is almost the whole point of this website. I’m trying, in what little way I can, to help ordinary investors think about the stock market as a long-term investment in relatively large and established companies, rather than a casino-like gamble on volatile share prices.

      And hopefully, focusing on five-year returns or longer will help them avoid panic-selling when their short-term returns (i.e. less than five years) are negative.

      But we’ll only know how effective I’ve been when the next major bear market rolls into town. And when that will be is anybody’s guess.

  5. Hi John.

    I’m curious about your thoughts on drip-feeding into a portfolio. Your model portfolio is based on one initial 50k lump, but I assume that in your real portfolio, you drip-feed (e.g. bump up your low-% good stocks), This would cause the long-term return on the real portfolio to deviate from that of the model.

    A simplistic example:

    10k over ten years at 10% return = 11k (10% ROI)
    10k over ten years at 10% return, adding another 5k after 5 years = 16250 (8.3% ROI)

    I just wondered if you have any thoughts on this. Is there a way of measuring the true performance? Or is that irrelevant, since you are comparing the model to the market, not to your real portfolio.

    1. Hi Kevin, yes in the real world money flows into and out of my portfolios, so tracking performance is much harder (that’s why the model portfolio avoid cash in and outflows!)

      There are at least two options: 1) Use Internal Rate of Return, i.e. XIRR function in a spreadsheet, or 2) unitise your portfolio just like a real unit trust.

      They’re both slightly involved topics so a web search is probably your best option. And a spreadsheet will make life very much easier.

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