How to Use Personal Returns

If you're like most investors, you pay close attention to the returns you get on your individual investments--and with the markets gyrating so wildly recently, you've probably been paying even more attention than usual. However, looking at individual investments' returns is an imperfect way to gauge how your portfolio is doing. A security's total return tells you how much it increased or decreased in value over a given period. However, it doesn't take into account the timing of investors' purchases or sales, thus possibly distorting the real-life experience of investors who add to or subtract from their investments over time. Morningstar Investor Returns for mutual funds, which we began showing on our Web site last year, take into account the money that has flowed into and out of a fund, providing a better picture of the average investor's experience with that fund. However, any given investor's experience won't necessarily correspond to that average. (You can read more about investor returns here and here.)

Personal returns, by contrast, attempt to provide a customized view of your own returns. Personal return is identical in concept to investor returns in that it accounts for how the timing of purchases and sales affects returns, but it applies to just a single portfolio--yours--rather than to all of a fund's shareholders as a group. Personal return measures the effect of your buying and selling on your own portfolio's returns--it tells you whether you've added value with your trading or whether you would have been better off buying and holding.

Understanding Personal Return
To understand the concept of personal return, consider a mutual fund with returns that have varied quite a bit from quarter to quarter, like this:

Q1: +20%

Q2: -20%

Q3: +5%

Q4: +10%

This fund's total return for the year is 10.88%. You can figure that number by multiplying all of the quarterly returns together, if they're appropriately expressed: 1.20 * 0.80 * 1.05 * 1.10 = 1.1088.

Now suppose we have three investors, named Smith, Jones, and Harris, in this fund, each with $100 to invest. Smith invests the whole $100 in the fund at the beginning of the year and then does nothing--a buy-and-hold strategy. His personal return for the year is going to be 10.88%, the same as the fund's total return. That's always the case for any period where an investor doesn't make any additions or withdrawals.

Jones only invests $50 in the fund at the beginning of the year and waits to invest the other $50 until after the second quarter, when the fund has just fallen 20%. Jones is being a contrarian, putting more money in the fund when it's down. That strategy definitely pays off in this case, because Jones' investor return for the year is 17.83%, significantly higher than the fund's total return. Jones benefited from good timing--only half of his investment was affected by that 20% decline, whereas all of it benefited from the subsequent rally.

Harris also invests $50 at the beginning of the year, but he invests the other $50 at the end of the first quarter, after the fund has just gone up 20%. Harris is being a momentum investor, adding more to the fund when it's hot. That turns out not to be a good strategy in this case, though; Harris' investor return for the year is only 1.88%, well below the fund's total return. That's not to say that momentum investing can never work, but in this case Harris' timing was terrible.

Using Personal Return
As noted above, personal return is actually the same thing as investor return, but on an individual scale. Technically speaking, both figures are versions of internal rate of return, or the return after accounting for the difference between the beginning and ending values of an investment, including cash flows in and out. You can find more details in the fact sheet for Morningstar Investor Returns, which includes an example illustrating personal return, or in the methodology document, which is for hard-core finance fans only.

Normally you need a financial calculator or a spreadsheet program, plus some know-how, to calculate such returns. However, Morningstar's Portfolio Manager allows you to see your personal return on any portfolio you've input, as long as it's a Transaction portfolio (where you record purchases and sales) and not a Watch List portfolio (where you're just tracking a group of stocks or funds). Just go to Portfolio Manager on Morningstar.com, find the portfolio you want using the drop-down menu in the top left-hand corner (if you have multiple portfolios), and click on the My Performance tab. On the My Performance page, you'll see both total returns and personal returns for this portfolio, as long as you've added to or withdrawn from the portfolio since starting it. If you haven't made any transactions, the two numbers will be the same, so only total return is shown. These returns are asset-weighted, like all the portfolio statistics in Portfolio Manager, so that each individual fund or stock contributes in proportion to its size within the portfolio.

Comparing your portfolio's total return and personal return can give you a good idea of how effectively you've timed sales and purchases. If your personal return is higher than your portfolio's total return, as with Jones in our example above, it means that the timing of your moves has had a positive effect. If, on the other hand, your personal return is lower than the total return, it means you've hurt your portfolio's returns and would have been better off just sitting tight rather than trying to time the market. If your personal return is substantially lower, it might be a good idea to reconsider the amount of trading you do.