5 tips on decoding investment performance

Looking at your short term performance can offer you some insights of your progress, but it can also be misleading and may not reflect the true health of your investment portfolio. In a world where financial markets can be volatile and unpredictable, it's essential to take a more holistic approach.

In this article, you will learn how to navigate common challenges when comparing investment performance, and you'll gain actionable insights to help you make better informed, long-term decisions. 💡

1. Keep the risk in mind

When reviewing past investment performance, it's tempting to focus only on the short-term performance. However, returns alone don't tell the whole story. Every investment comes with its own level of risk, and what might seem profitable in the short term could carry hidden long-term vulnerabilities. It's crucial to balance the allure of returns with an understanding of these risks. Otherwise, you might get a skewed perception of how well your investments are actually doing.

A practical example: Bitcoin vs. S&P 500

Consider the past year, from September 2022 to September 2023. Both Bitcoin and the S&P 500 yielded nearly identical performance numbers. However, the risk associated with each couldn't be more different. Bitcoin's price is known for its extreme swings (volatility) , while a diversified market index like the S&P tends to have comparably lower price swings.

2. Look at the big picture

It is natural to be drawn to recent successes but the true test of an investment’s success lies in its long-term performance. A mutual fund (a pooled collection of assets that invests in stocks, bonds, and other securities) that was highly successful this year might have a mediocre or poor track record over the past five years. If one only focuses on the immediate gains there is a chance to miss out on better long-term investments.

A practical example: Zoom

The stock of the video meeting platform “Zoom” saw a meteoric rise during the pandemic, capturing the attention of many investors and analysts. Comparing its performance to other investments while it was at its peak would have been misleading. A deeper dive into its long-term performance reveals that the stock faced significant challenges after the initial high. Evaluating its performance based solely on this short-term peak would have been a classic case of "chasing the hot hand." This shows  the importance of considering performance over different timeframes.

3. Don't forget the costs

While performance metrics often steal the spotlight, fees and costs are the unsung factors that can significantly impact your investment returns over time. These might seem like minor details, but they can add up to a substantial amount, especially when compounded over several years.

Imagine you're comparing two funds: one with slightly higher returns but also higher fees. The other with lower returns and lower fees. At first glance, the higher-performing fund may seem more attractive. However, when you account for the fees, the picture changes. Those high fees can erase your gains, making what initially appeared to be a better investment less profitable in the long run.

It's crucial to look for investments that are transparent about their fee structures. Hidden fees can be particularly damaging as they can catch you off guard and eat into your returns. Over years it has been a common behaviour of the financial industry to be intransparent about costs. Always read the fine print and ask questions if you're unsure about any costs involved.

4. Don't forget the currency

When evaluating investment performance, it's easy to overlook the impact of currency exchange rates, especially when investing across borders. For example, let's say you invest in a foreign stock that gains 10% in its local currency. Sounds great, right? But what if, during the same period, your own currency appreciates by 5% against that foreign currency? In that case, your actual return, when converted back to your home currency, would be less impressive.

Currency exchange rates can significantly impact your investment returns. When comparing performance, especially of international investments, always take into account the effect of currency fluctuations to get a true picture of your returns.

5. Keep an eye on the market conditions

Understanding your portfolio's performance requires a broader perspective, considering not just the absolute figures but also the overall market conditions and your strategy. For instance, in turbulent market conditions, a portfolio that remains stable or experiences minimal fluctuations showcases the strength of a well-diversified and strategically managed investment. It's essential to measure success not just in immediate returns but in the resilience and long-term growth potential of your investments.

Let’s look at the following examples: When global markets crash and are down by 30% and your global investment portfolio returns with -20% this is 10% better than the market. You have actually won 10% in comparison to the market.  

On the other hand when markets are up by 30% and your investment portfolio returns with 20% that's less good. Even though you made money, your return is 10% less than the expected market return. You have actually lost 10% in comparison to the market. 

Conclusion

Comparing investment performance may seem like a straightforward task. As we have seen, it is anything but simple. From ignoring risk levels to overlooking personal objectives and market conditions, there are numerous pitfalls that can mislead even the most seasoned investors. The key takeaway is performance numbers alone don't tell the whole story. To make informed decisions, it's crucial to consider a range of factors, including risk, fees and market context.