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10 things you should know about portfolio performance

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Performance is more than just numbers.

Whether you're evaluating your portfolio or contemplating making an investment, what matters most is performance.

OK, maybe investors should care more about other things, but in the real world they don't.

As an investor, you perform in lots of ways. Are you a good saver? Are you a good spender? Are you good at living within your means? Are you good at choosing smart investments? Are you good at controlling your emotions when the market takes you on a roller-coaster ride?

It's all about performance — but those things are all about you. If you are like most investors I know, you are much more interested in how your investments are performing for you.

Fair enough. Here are 10 things about investment performance you should know and never forget:

1. Total performance

You've got to know how you are doing performance-wise. Otherwise, how will you know if you are in the ballpark of reaching your goals? And how will you brag to your friends?

At least once a year, calculate the performance of your whole portfolio, and write this down for future reference. Resist any temptation to focus only on a few assets that are doing well. What really matters is the package.

2. Don't extrapolate

Maybe you were up 10% last year. That's fact. The danger is thinking that's what you can expect in the future and running the numbers out 10 or 20 or 30 years to conclude that you'll be on top of the world. Such a fantasy might lead you to stop saving money — which would be a big mistake.

3. Time matters

Performance figures based on 50 years of data are much more meaningful than those based on 10 years, five years or six months. Not every asset class has a long history, of course, and we have to do the best we can with the data we have.

4. Past performance is not an indication of future results

Recent performance is no more valid than performance from farther back in history.

Millions of investors learned this the hard way in the first decade of this century after the marvelous returns of the Standard & Poor’s 500 Index SPX, -0.34% led them to bulk up on that asset class in the belief that 18% to 25% had become "the new normal."

Two severe bear markets later, the S&P 500's long-term historical performance started looking like "the good old days."

5. Losses are normal

Whatever you invest in, be sure you are comfortable with the losses you are likely to experience. As DALBAR studies have shown for more than three decades, most investors don't even achieve 50% of the returns of the market, much less beat the market.

One main reason is that investors are shocked to discover they have lost money, even if the loss is well within the norm. Instead of thinking things through, they panic and sell, ironically locking in the losses that stunned them in the first place.

6. Average investment returns are meaningless

If you gain 50%, then turn around and lose 50%, on average you have broken even, right?

Sorry. If you start with $10,000 and gain 50% in a year, you have $15,000. If the following year brings a 50% loss, you wind up with $7,500. That's not breaking even; it's losing 25%.

In the real world, you will achieve compound returns (in this case an annualized loss of 13.4%), not average ones. That's where your focus should be.

7. ‘Above average’ is a poor benchmark

Tons of data exists showing that, in any equity asset class, the majority of mutual funds fail to match the performance of the low-cost index fund in that asset class.

In 2014 the average U.S. large-cap blend fund gained 11%, according to Morningstar, while the Vanguard 500 Index Fund VFINX, -0.31% was up 13.5%.

8. Many forces determine portfolio returns

If you're regularly adding money to an account, as most people do in 401(k) plans and IRAs, you will have a series of many small investments, each with a different starting date and a different duration.

No matter how much you try to control everything, your long-term returns will be affected by random events that nobody can predict.

9. Don’t listen to braggers

Friends, neighbors and relatives may tell you what returns they are getting. Don't believe them. When they have lost money or made dumb mistakes, they're highly unlikely to come brag to you.

And do you even imagine that they will show you their actual statements to prove their case?

Most people, in fact, don't even know their own performance returns. I know mine only because of an expensive piece of software used by my adviser. Two separate studies found a difference of more than two percentage points between investors' actual returns and what they thought they had been getting.

10. Don’t be overly impressed by fund company performance

"Survivorship bias" means returns are often overstated, sometimes by as much as five percentage points a year.

Here's a hypothetical example of how that can happen. Imagine a fund company started out with five relatively similar funds, two of which turned out to be dogs.

If the company closed the poor funds and kept the good ones, suddenly its average would look much better. The funds that survive, by definition, are the ones that perform well enough not to be an embarrassment.

Among hedge funds that have been started in the past 15 years, only about 5% have survived. That means that the performance of "the average hedge fund" looks much better than most hedge fund investors experienced.

Performance is more than just numbers. It's also the topic of a podcast I have recorded, and which you will find here.

If you keep these points in mind, I'm pretty sure your investment performance will improve. In the end, that's what it's all about.

Richard Buck contributed to this article.