Measuring Portfolio Returns

On the surface, measuring your portfolio’s return and comparing it to some index seems like it should be easy: take the final value, divide by the starting value, and compare. However, there can be a number of complications. This is my attempt to evaluate my investing performance.

Over the years I’ve done many approximate calculations to assess my stock-picking ability. A few months ago I met with Preet Banerjee of Where Does All My Money Go? fame, and he asked me how my stock picking results compared to index returns. This innocent question left me stammering because I knew I had only approximated the answer. Without taking into account all factors, I couldn’t be sure.

I fired my financial advisors and started investing on my own roughly the middle of 1998. I completed a nearly full transition to index investing roughly the middle of 2010. So, the period of interest for measuring my stock-picking results is this span of 12 years.

However, I did not start with one lump sum of money. I made literally hundreds of deposits and withdrawals to and from 9 different trading accounts. Figuring out a rate of return over these 12 years requires an Internal Rate of Return (IRR) calculation. (There are cases where IRR does not work well, but that is not the case here as it turns out.)

There were two different ways to go with this calculation:

1. Track all the account withdrawals and deposits.

2. Track all the stock-related transactions such as trades, commissions, fees, dividends, and income tax payments.

I decided to go with approach 2 because I want to focus on stock-picking results and not mix in results from cash, bonds, and other non-stock investments. Here are some statistics from the large spreadsheet I generated:

– 144 months
– 88 stock purchases
– 91 stock sales
– 398 dividend payments
– Many commissions and fees that I lumped together each month

Also included on the spreadsheet were all the income taxes I paid on capital gains. I did not include taxes paid on dividends because these taxes would have to be paid on index dividends as well. This gives an apples-to-apples comparison between my return and index returns when the index returns include dividends but not income taxes.

A minor quibble is that the index approach would have a bigger built-in capital gain (or at least a smaller capital loss). It’s hard to value the accumulated capital loss my portfolio generated that I am able to carry forward. This difference puts my return at a disadvantage compared to indexing, but I’m just going to ignore it because the combination of available RRSP and TFSA room makes it unlikely that I will ever use up all of this accumulated capital loss.

(Some readers may wonder how a fairly successful portfolio could build up a large capital loss. The answer is related to technical differences in the ways that stock gains and stock option gains are taxed.)

I performed the IRR calculation and also calculated the stock index returns for Canada and the US for the period from 1998 July 1 to 2010 July 1:

Me: 9.6% per year (my portfolio accounting for capital gains taxes)
Canada: 5.9% per year (S&P TSX Composite total return)
US: -1.6% per year (S&P 500 total return measured in Canadian dollars)

So, I beat the index by a decent margin. Is this edge statistically significant? Am I some sort of stock-picking savant? Hardly. Let’s try a little sensitivity analysis.

For many years I held stock in the company I worked for and this continued long after I stopped working for them. I obtained most of this stock through stock options. So as not to throw off the calculations, I treated the options as though I purchased them at the value they had when I was first allowed to exercise them. Over the years I exercised the options and sold the resulting stock in bits and pieces. At the end, the remaining shares were nearly worthless.

What happens to my returns if we eliminate my 3 biggest stock sales one at a time? I recalculated my compound average return assuming that these trades never happened and that I held the shares until the same day I got rid of all the other remaining nearly worthless shares. Here goes:

Return without biggest sale: 2.6% per year
Return without 2 biggest sales: -1.0% per year
Return without 3 biggest sales: -2.4% per year

My results on this stock completely swamped all other stock trades I made. The employer shares I sold early gave phenomenal gains and the ones I held to the end gave dreadful losses.

In the end I don’t really know if I’m any good at stock picking, but I doubt it. I’m content with my decision to switch to mostly indexing, and I’m happy to have been lucky for 12 years.