Category: Investment Management

How often is portfolio evaluation needed

How often is portfolio evaluation needed

The portfolio performance evaluation primarily refers to the determination of how an investment portfolio has performed relative to its comparison benchmark in the specified category. The evaluation can indicate the extent to which the portfolio has outperformed or under-performed, or whether it has performed at par with the benchmark.

What is a Portfolio?

A combination of various investment products like bonds, shares, securities, mutual funds and so on is called a portfolio.

In the current scenario, individuals hire well trained and experienced portfolio managers who as per the client’s risk-taking capability combine various investment products and create a customized portfolio for returns in the long run.

It is essential for every individual to save some part of his/her income and put into something which would benefit him in the future. A combination of various financial products where an individual invests his money is called a portfolio.

What is Portfolio Evaluation?

The art of changing the mix of securities in a portfolio is called as portfolio evaluation.

The process of addition of more assets in an existing portfolio or changing the ratio of funds invested is called as portfolio revision. The sale and purchase of assets in an existing portfolio over a certain period to maximize returns and minimize risk is called as Portfolio evaluation.

The evaluation of portfolio performance is important for several reasons. First, the investor, whose funds have been invested in the portfolio, needs to know the relative performance of the portfolio. The performance review must generate and provide information that will help the investor to assess any need for rebalancing of his investments. Second, the management of the portfolio needs this information to evaluate the performance of the manager of the portfolio and to determine the manager’s compensation, if that is tied to the portfolio performance.

Why is portfolio evaluation needed?

Evaluation of the performance measurement is necessary for investors and portfolio managers both. However, the need for evaluating may be different for these two sets of people. Performance evaluation also shows the areas of effectiveness as well as improvements in the investment scheme. Some of the benefits for evaluating the portfolio performance include the following:

  • The return performance of the investment over time (performance measurement)
  • How the observed performance is attained (performance attribution)
  • If the performance is due to investment decisions (performance appraisal)

An individual at certain point of time might feel the need to invest more. The need for portfolio revision arises when an individual has some additional money to invest.

Change in investment goal also gives rise to revision in portfolio. Depending on the cash flow, an individual can modify his financial goal, eventually giving rise to changes in the portfolio i.e. portfolio revision.

Financial market is subject to risks and uncertainty. An individual might sell off some of his assets owing to fluctuations in the financial market.

Methods of portfolio evaluation

There are two broad categories of portfolio performance evaluation methods:

1. Conventional Method

The conventional method of performance evaluation doesn’t take into account the risks taken by the portfolio manager. In this method, the performance of a portfolio is evaluated by comparing the portfolio returns to the returns of a benchmark, which can be a market index, such as S&P 500, or another similar portfolio.

Comparing only the returns, your portfolio has given better returns (20%) than the market index, which gave 15%, irrespective of the fact that it had higher risk than the market.

2. Risk-adjusted Methods

In these methods, the returns of the portfolio are compared to the returns of the benchmark, considering the difference in their risk levels. The most common methods to do this are:

Sharpe Ratio

The Sharpe ratio is defined as the risk premium of the portfolio per unit of total risk in the portfolio. Risk premium calculated by subtracting risk-free returns from the portfolio returns. The risk-free returns are measured as the risk-free interest rate of Treasury bonds.

Treynor Ratio

The Treynor ratio of a portfolio is calculated by dividing the risk premium by the systematic risk of the portfolio. It assumes that no diversifiable risk is present in the portfolio.

Here are 5 tips on evaluating your investment portfolio performance-

1) Review your present net worth and particularly, the value of your investment portfolio regularly. Knowing where you stand is the first step to gauging how well you’re doing overall.

2) Check how your portfolio is doing against its benchmarks. With the markets, everything is relative. You’re doing very well if you’re investments are performing at least as well as their respective indexes. Check each of the asset classes that are represented in your portfolio and see how they’re doing against their comparative index and if there are discrepancies, figure out why!

3) Compare the individual investments in your portfolio against their peers in the same asset class. Each of your funds or stocks is part of a bigger universe of like investments. Compare how your individual fund or stock is behaving relative to other funds or stocks that are in the same industry or sector. You’ll have to be careful about comparing apples to apples though, but if you note some glaring differences or a pattern of underperformance, it may be time to do some switching.

4) Ensure that your investments remain on target according to your established goals. Evaluate how each investment is doing and confirm its place in your overall plan. Since our lives shift and turn with the years, it is also quite possible that our investments may need to be revisited and perhaps adjusted accordingly.

5) Make the necessary updates and tweaks to your portfolio on a regular basis. If need be, take action and do the necessary work to readjust your portfolio. If your portfolio has shifted from its desired allocation, or your life plan has put a monkey wrench on your financial picture, then make the changes.



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