Common mistakes when evaluating performance

Published 2:32 pm Friday, April 9, 2010

As an investor, you might think it’s easy to evaluate your investments’ performance.

After all, the bigger the gain, the better, right?

This statement is true enough, but as an investment strategy, it’s incomplete—and, if followed rigidly, it could lead you to make some mistakes that could hinder your progress toward your financial goals.

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What are some of these potential mistakes?

Here are a few to consider:

 Evaluating performance over a short period of time—If you measure an investment’s performance over a relatively short period of time, you may be more tempted to invest emotionally—that is, you’ll buy more shares of an investment when you “feel good” about it because its price has risen, and you’ll sell more shares when you “feel bad” because the investment’s price has fallen.

This behavior is the opposite of the classic piece of investment advice: “Buy low and sell high.”

Try not to make investment decisions based on short-term performance. Instead, look at an investment’s long-term track record.

While it’s true, as you have no doubt heard, that “past performance can’t guarantee future results,” it’s nonetheless useful to see how an investment has fared in different market environments.

 Neglecting the impact of contributions and withdrawals—If you put more money into an investment, it will be worth more—until the price drops—and if you take money out of an investment, it will be worth less—until the price rises. Yet many people mistakenly attribute their investments’ performance to these inflows and outflows.

 Failing to distinguish between “growth” and “income” investments—To help achieve your long-term goals, you’ll need a mix of growth-oriented investments, such as stocks, and income-producingvehicles, such as bonds. However, bonds will typically not add much growth to your overall portfolio, so keep this in mind when you look at the year-to-year change in value on your investment statements.

 Maintaining unrealistic expectations—In 2009, the Dow Jones Industrial Average rose nearly 19 percent, while the S&P 500 jumped more than 23 percent. But if you anticipate such unusually high returns annually, and you base your investment strategy on them, you’ll likely be disappointed and have trouble meeting your goals.

For a variety of reasons, most investment experts foresee relatively modest returns in the financial markets over the next few years, so you’ll want to plan accordingly.

 Comparing investments to benchmarks—Try not to compare the performance of your investments to benchmarks such as the Dow Jones Industrial Average or the S&P 500. If you’ve chosen an aggressive investment mix, your returns may show wide swings, beating the benchmarks substantially in some years while trailing them significantly in others. On the other hand, if you’re a conservative investor, your returns may consistently lag the major benchmarks, but you’ll probably experience less volatility.

Once you know what to expect from your investments, you’ll be less likely to be disappointed at your returns—and you’ll be better prepared to create and follow an investment strategy that works for you.