Is your investment portfolio delivering good returns?

Some investors believe returns generated by their portfolios are sole measurements of performance . No doubt returns are critical, but there are other factors that must be considered when evaluating your portfolio too.

Here are some:

Risk

Risk and reward are two sides of a coin. The more the risk, greater will be the reward. A portfolio that is heavily invested in small little-known companies may be delivering high returns. However, it may be risky as its returns may not be consistent .

Time horizon

When calculating investment returns, flows during the relevant period must be considered. The investment's time horizon could range from a month to a few years.

Market price

When computing gains and loss all securities must be considered at their market prices. This way, fairly accurate investment returns are reflected across the securities.

Determine a benchmark

When measuring a portfolio's performance, it is essential to have a benchmark that truly reflects the objectives of the portfolio that is being evaluated. The benchmark index or portfolio helps compare returns obtained from a fund with the returns that could have been obtained from an index or a benchmark.

Diversification

A well-diversified portfolio may have lesser risk associated with it. It may be less volatile and yielding consistent returns. The extent of portfolio diversification should also be considered when measuring portfolio performance.

The Sharpe ratio evaluates a portfolio based on the rate of returns and extent of diversification. It uses the standard deviation of returns as a measure of risk. The ratio has the ability to judge if the performance of a portfolio is due to excessive risk exposure or good investment strategy.

The ratio of average rate of returns from a portfolio minus the average rate of returns from risk-free assets during the same time, and the standard deviation for the portfolio, gives the Sharpe ratio. Sharpe ratio is therefore equal to (expected portfolio returns minus risk-free returns) divided by the portfolio's standard deviation.

The Sharpe ratio's measurement of a portfolio's returns is useful to determine if higher returns have come with excessively increased risk. The greater a portfolio's Sharpe ratio, the better is its risk-adjusted performance.

Another measure that can be used to evaluate a portfolio is the Treynor measure. The Treynor measure is also known as the reward-to-volatility ratio. Treynor ratio is equal to (portfolio's returns minus risk-free returns) divided by beta. The higher the Treynor ratio, the better is the performance of the portfolio under analysis.

There are many more measures for evaluating a portfolio's performance like the Jensen's alpha method. Quantifying and measuring both risk and rewards will help give a more accurate picture of your portfolio performance.

Source: EconomicTimes