Who: This post is for people who look at their portfolio return and have no idea whether or not their return is good, bad or average. If you’re looking for a framework through which to evaluate your portfolio returns, this post is for you.
What: This post will discuss how to benchmark your portfolio’s return. You will find out how to decide whether or not your portfolio is performing as well as it should.

I got the idea for this post from a question asked by a reader of Consumerism Commentary. I posted a comment in response, and decided that it may be helpful to the readers of A Financial Revolution. As such, I have reposted the comment here with some significant additions and elaborations.

So, what is a good rate of return? This is a pretty important question. Unfortunately, it does not have a simple answer. The most important piece of information that one needs to take out of this discussion is that the return of a portfolio by itself is almost meaningless without context. So, what context do we need? The answer is risk.

The first thing one needs to take a look at the risk of his/her portfolio. There are many ways to do this. I find that the simplest is calculating the standard deviation of daily returns. If this is not available (or you are not sure how to do this), try a weighted average of the standard deviation of the individual components (Many places have this information available). This might become cumbersome, but it is somewhat important to assess the risk of your portfolio in SOME way.

Note: Stay tuned for an upcoming post that will actually discuss how you, the individual investor can quickly and (relatively) easily calculate the standard deviation (and other various metrics) of different investments. I will provide a step-by-step guide.

Once you have evaluated the risk of your portfolio, you can find other indices (S&P, Wilshire 5000, Lehman Bond Fund) that have a comparable risk to your portfolio. Remember that for many investors, low volatility bonds returning 5% are much better than high volatility stocks returning 7% (Sharpe Ratio). As such, it is imperative that you compare the returns of your portfolio to other portfolios that have taken on a similar amount of risk. If you find that your portfolio risk was very close to the risk of the S&P 500 index, then you can use the S&P 500 as a benchmark. If your portfolio was very conservative and had a standard deviation of maybe 3 or 4%, as opposed to 9%+, then maybe you could compare your returns to that of a bond index instead.

Ultimately, the pure return you get from your portfolio may sound good or bad based on the “averages” you see quoted around the personal finance spheres and the standard “8% assumed growth” you see everyone talking about, but it doesn’t really mean much without an assessment of risk, along with the return.

To summarize… Assess the risk of your portfolio. Compare the returns of your portfolio to indices with similar risk. If your portfolio outperforms others with similar risk, then you’re in great shape. If they don’t, maybe you’d be better off with an index fund.

Popularity: 11%