A Method to Calculate Historic Portfolio Performance

I find that in life if you want to succeed at something you must have a plan.  This plan in its most basic form will include a number of goals and a timeline detailing when you intend to meet those goals.  Once you have that plan in place you must then track progress against the plan and should you deviate you should put actions in place to get you back on track.  Personal Finance is no different.

Within the Invest Wisely portion of my strategy I have two distinct goals for my Low Charge Portfolio.  The first is to beat a Benchmark that I have set myself.  Everybody’s Benchmark will of course be different.  It could be to beat the FTSE100, the FTSE 250, the Barclays UK Government Inflation-Linked Float Adjusted Bond Index, a combination of these or something completely different.  Remember when you set your Benchmark you must ensure it has a similar risk profile to your investments and contains investments that are as close to yours as possible.  What good is it to spend time developing a Low Charge Portfolio and Strategy if you can’t at least match (for those of us where personal finance is a hobby) or beat a simple Benchmark (for those of us where personal finance is a hobby or chore).  If we can’t meet this goal then we’re probably better off just buying a Vanguard LifeStrategy Fund.

The second aim is for my portfolio to over the long term meet or exceed a Real Total Return goal that I have set myself.  This is defined as over the course of my investing career the sum of the capital gains within my portfolio and the dividends paid must exceed UK Inflation by a specific amount.  In the interests of full transparency I must point out that I am current not meeting my goal however by tracking progress I at least know why I am missing and have planned actions to recover.

Let’s look at the method I use to calculate the historic performance of my portfolio assuming I want to look at Total Return.  Calculating Real Total Return is then just a simple matter of subtracting your chosen inflation measure from the calculations for the period concerned.

Calculating Year to Date and Yearly Total Portfolio Return

To make this calculation you only need 4 things:

• Access to the XIRR function within Microsoft Excel.  This function is not typically part of the standard Excel install so if you have Excel and can’t find XIRR you may need to install what is called the Analysis Toolpak.  As every version of Excel is slightly different just type “Install Analysis Toolpak” into Excel’s Help and you should get the guidance you need for your version.
• The start date for the period you are interested in analysing and the value of your portfolio on that date.  This must be the earliest date entered into Excel.
• The end date for the period you are interested in analysing and the value of your portfolio on that date.  When running the calculation this value should be entered as a negative number.
• Any cashflows into or out of your portfolio.  Note that because I am calculating Total Return all of my dividends have been reinvested in my portfolio and so I don’t need to include any dividends within the cashflows.  Cash into the portfolio should be entered as a positive number and cash out should be entered as a negative number.

A worked example is shown in the image below.

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A couple of important points:

• The first column entry into the XIRR formula is the cashflows, the second column is the dates and the third piece of data you have to enter is a guess as to what the return might be.
• It doesn’t matter what the period you are using is, whether 1 month, 1 year or 10 years, the return will always be an annualised return.  So in the example above, which is only a 3 month period, were the year continue at the current rate of return then you’d see a return of 64.7%.  You have not achieved a 64.7% return over that 3 month period.

At this point if you only want to calculate your total return for a whole year, say 31 December 2011 to 31 December 2012, then you are done.  If however you would like to know what your return is year to date then you have a little more work to do.  I do this because I don’t want to wait a whole year to understand if I’m going off plan.  I update my financial position weekly and then update my portfolio performance on the first Saturday of every month.   To do this you now need to calculate your Personal Rate of Return (PRR) which is represented by the formula:

Let’s continue with our worked example and now calculate the Personal Rate of Return.

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Another important point:

• Note how even though we are looking at a 3 month period the PRR is not equal to the XIRR value divided by 4.

So that’s how to calculate year to date and yearly performance.  Let’s move onto calculating performance over a number of years.

Investing for Income via Higher Yielding Shares

I’d like to welcome back John Hulton.  John claims to not be a financial guru, stockbroker or financial journalist, but just an average bloke who has managed to find a way through the minefields of personal finance and develop a system that works for him and, which could be helpful for other people.  He has already retired from full time work which puts him at the end game of what this Site is about – Save Hard, Invest Wisely, Retire Early.  The fact that he did this at 55 means his Save Hard, Invest Wisely element worked for him.  So while John is not a financial expert his approach has given him what many of us are chasing.  I hope you again enjoy his thoughts.

There’s no getting away from the fact that the past 4 or 5 years have been tough for savers and pensioners.  The Bank of England has kept interest rates at a record low 0.5% for the fourth consecutive year.  Annuity rates are equally at an all time low and there appears little reason to think there will be any significant change for the foreseeable future.

According to a recent study by Prudential, people retiring this year will have a typical yearly income of £15,300, around £3,400 less than those who retired in 2008.  In a separate report by Moneyfacts, they found that annuity income fell by 11.5% in 2012, the biggest annual fall since 1998.

Understandably, many savers are looking for alternatives which can provide a better return than the 2% or so on offer from their bank or building society.  Likewise, people approaching retirement are investigating alternatives to the rock-bottom annuity rates currently on offer.

One way to maximise income is to invest in a diverse portfolio of large, well-run companies which will grow their earnings and profits for the decades ahead.  Companies which have weathered the storm over the past 5 years and have also managed to maintain a steady stream of rising dividends are likely to continue doing this in the future.

In my ebook Slow & Steady Steps from Debt to Wealth I set out a step-by-step guide to generating income from the stockmarket.  I have found, through a process of trial and error over several years that a combination of individual higher yield shares together with a portfolio of investment trusts gets the job done for me.

In a post earlier this month I outlined some of the benefits of investment trusts and in this second part, I will cover my higher-yield shares portfolio.

For me, the main advantage of holding individual shares is lower ongoing costs - after the initial purchase, which could be as low as £1.50 plus 0.5% stamp duty, there are no further costs involved in holding the portfolio.  I suppose if you are in the build phase and reinvesting dividends from time to time in more shares, there will be some further minor cost but basically, once you have purchased your 15 or 20 shares that’s it.  With investment trusts there are the same initial costs to purchase PLUS the trusts annual expenses and management fees - usually between 0.5% and 1% (plus any performance fee).

The FTSE 100 Cyclically Adjusted PE Ratio (FTSE 100 CAPE or PE10) – January 2013 Update

This is the Retirement Investing Today monthly update for the FTSE 100 Cyclically Adjusted PE (FTSE 100 CAPE).  Last month’s update can be found here.

As always before we look at the CAPE let us first look at other key FTSE 100 metrics:

• The FTSE 100 Price is currently 6,104 which is a gain of 4.0% on the 03 December 2012 Price of 5,871 and 7.1% above the 02 January 2012 Price of 5,700.
• The FTSE 100 Dividend Yield is currently 3.64% which is a little down against the 03 December 2013 yield of 3.73%.
• The FTSE 100 Price to Earnings (P/E) Ratio is currently 11.78.
• The Price and the P/E Ratio allows us to calculate the FTSE 100 As Reported Earnings (which are the last reported year’s earnings and are made up of the sum of the latest two half years earnings) as 518.  They are up 1.1% month on month but down 6.5% year on year.  The Earnings Yield is therefore 8.5%.

The first chart below provides a historic view of the Real (CPI adjusted) FTSE 100 Price and the Real FTSE 100 P/E.  Look at the trend line of the Real Price.  After you strip out the effects of inflation the perceived market value is doing not much more than oscillating above and below a flat line.  This then presents a problem for any buy and holder reinforcing the importance of dividends.  The second chart provides a historic view of the Real Earnings along with a rolling Real 10 Year Earnings Average for the FTSE 100.

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As always let us now turn our attention to the FTSE 100 Cyclically Adjusted PE.  This is also shown in the first chart above.  For completeness let me also detail the usual reminders.  I do not use P/E ratio’s to make investment decisions from and instead use this CAPE.  This is because the P/E ratio does not take the business cycle into account which the CAPE tries to adjust for.  The method used is similar to that developed by Professor Robert Shiller for the S&P500.  The calculation is the ratio of Real (ie after inflation) FTSE 100 first possible day of the month Price to the 10 Year Real (CPI adjusted) first possible day of the month Earnings.  Unfortunately the dataset I have created only goes back to July 1993.  Therefore to get a meaningful set of numbers I have had to average in to a PE10 for the first 10 years.  What this means is that July 1994 is actually a PE1, July 1995 is a PE2 and so forth until July 2003 when we have a full FTSE 100 PE10.

The ASX 200 Cyclically Adjusted PE (aka ASX 200 PE10 or ASX200 CAPE) – January 2013 Update

This is the Retirement Investing Today monthly update for the Australian ASX 200 Cyclically Adjusted PE (ASX 200 CAPE).  The last update can be found here.

Before we run the CAPE analysis let us first look at some of the key Australian Stock Market metrics:

• The ASX 200 Price at market close on Friday was 4,709 which is up 1.3% from last month’s Price of 4,649 and up 10.5% year on year.
• The MSCI Australia Dividend Yield is currently 4.6%.  I accept this Index as an ASX200 proxy for both Dividend Yield and P/E Ratio based on this analysis.
• The ASX 200 Earnings (calculated using MSCI Australia P/E Ratio and ASX 200 Price) are currently 304.  This gives an Earnings Yield of 6.5%.
• The MSCI Australia P/E Ratio is currently 15.5 compared with the dataset (since December 1982) average P/E of 18.3

The first chart today shows a historic view of the Real (inflation adjusted) ASX 200 Price and the ASX 200 P/E.  The second chart provides a historic view of the Real (after inflation) Earnings and the Real (after inflation) Dividends for the ASX 200.

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A Retirement Investing Today Review of 2012

This is a belated 2012 review of my own personal situation.  It comes a little later than most personal finance bloggers for 2 main reasons:

• A portion of my exposure to Australian Equities is held with Vanguard Investments Australia in the form of the Vanguard Index Australian Shares Fund.  This fund distributes income on the 31 December and so it takes a few days for the distribution to be declared and the unit price to adjust.  I can’t close out my year until this occurs.
• I monitor the value of the Retirement Investing Today Low Charge Portfolio on a weekly basis rolling up the values every Saturday.  This means for me my year actually started at the market close on the 06 January 2012 and finished on the market close on the 04 January 2013.

My personal investing strategy is now aligned around the mantra – Save Hard, Invest Wisely, Retire Early so let’s review my year around those 6 short words.

Save Hard

My aim is to regularly save 60% of my earnings.  Earnings I define as my gross (ie before tax) earnings plus any employee pension contributions.  When the year is rolled up I actually missed my target with a result of 55% of earnings being saved.  So where did the money go:

• 32% was invested into Pension Wrappers
• 18% was invested into ISA’s, NS&I Index Linked Savings Certificates and non tax efficient locations 
• 5% was used by my better half to ensure both our early retirement ambitions stay in sync.  Therefore this money didn’t make it into my Invest Wisely but are still family savings so I’ve chosen to include them.

Year end score: Conceded Pass.  The amount saved was nowhere enough for Early Retirement Extreme however it should still be plenty for a nice Early Retirement.  My plan for next year is to get that savings rate back up to 60%.

Invest Wisely

I have continued with the Retirement Investing Today Low Charge Strategy.  My asset allocations at year end are shown in the chart below.

 

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I have continued to invest as tax efficiently as possible.  At year end 69.1% of the total portfolio is invested this way with the distribution being:

• 39.2% held within Pension Wrappers with the majority being within a Sippdeal SIPP
• 17.3% held within NS&I Index Linked Savings Certificates
• 12.6% held within ISA Wrappers.  100% of which is invested within the TD Trading ISA.  I continue to use TD Direct Investing as the Investments I hold within the ISA, plus the fact that I have over £5,100 with TD means I have no annual fees to pay.  This helps ensure I minimise fees and taxes and not just taxes.

Year end score: Pass.  Sure I am only 69.1% tax efficiently invested but I have at least maximised the opportunities made available to me in the year while ensuring I maintain my risk profile.