Deciphering Your Statements
While your advisor is legally required to provide you with periodic financial statements on your accounts, it can be difficult to decipher what the statements are telling you. Here are a couple of things to look for and what they mean when reading your statements.
When it comes to calculating the performance on your account, it may surprise you to find that there is more than one way to go about it. In my opinion, the easiest calculation is what is known as the Holding Period Return, which is basically your ending balance divided by your beginning balance minus one. So for example, if I started with $100 and ended with $105, my holding period return would be 5% (105/100 -1 = .05). Unfortunately, investing is rarely that simple, which is why so many other formulas for calculating returns have arisen. While we won’t go into the more complex math, here are two of the more popular return calculations that you may find in your statements:
Time-Weighted Return (TWR): This return calculation focuses on the timing of your investments (when the different investments are made), making it a little bit more accurate than a simple holding period return calculation.
Internal Rate of Return (IRR): This return has to do with the movement of cash into and out of the account and the growth rate that causes the outflows to equal the inflows. It is sometimes also called the Money-Weighted Return (MWR). There are limitations to the calculation for the Internal Rate of Return particularly when negative performance is present, which is why it's usually best to use the Time-Weighted calculation for presenting performance.
Gross versus Net
Another set of terms you may hear when it comes to performance reporting is gross versus net. You can think of the gross return as the return on your investments before all of the fees have been deducted and net return as the return on your investments after all of the fees have been deducted. For example, let’s say that your gross annual return was 5%, but your investment advisor charges you 1%. That would mean that your net annual return is actually 4% (5% - 1% = 4%). The net number is more important than the gross number because it is the actual total return to you after all of your expenses on investing. One of the best ways to tell if your advisor is being transparent about performance and fees is if they show net performance.
Standardized Time Periods
One of the best ways to identify good financial reporting is consistency. When you receive your statements, compare them to prior statements and see if they are formatted similarly, particularly when it comes to time periods. Industry best practice dictates using a set of common time periods for performance reporting on every statement. These time periods should include Year-To-Date and Previous (or Rolling) 12 Months as a minimum. Some advisors may also choose to include other time periods such as Previous 3 Months, Quarter-To-Date, or Previous 6 Months. What’s important to look for is that they use the same metrics each time. If the dates look weird or the metrics are constantly changing, it may mean that your advisor is cherry picking performance.
While advisors aren’t required to include a benchmark, it can be an incredibly helpful tool when it comes to having a helpful comparison point for understanding your performance. Similar to time periods, you’ll want to look for consistency. If the benchmark is a different benchmark each time, then it is of no use. Furthermore, a good benchmark is one that you can understand and that makes sense for your investments. A benchmark that is 100% stock isn’t a good benchmark if your investments are primarily bonds. Similarly, if you don’t know what’s in a benchmark or don’t understand the name, there’s no way of knowing if you’re comparing apples to apples or apples to kumquats. If you don’t understand a benchmark, ask your advisor to clarify.
Finally, while disclaimers can be dry, boring, and hard to read, it’s important not to ignore them especially when it comes to financial reporting. On multiple occasions, I have found myself marveling at a fund’s performance only to read in the disclaimer that the performance is hypothetical or based on back-testing and not what actually happened. Disclaimers exist because they are meant to hold advisors accountable for the data they’re providing to you, but the only way that works is if you take the time to read and understand the disclaimers.
These are just a few things to consider when it comes to investment reporting. If you’d like to learn more about how the calculations work, how to read your statements, or what certain terms mean, please don’t hesitate to give us a call, but don’t just take our word for it. There are a variety of other, credible third-party resources available to you online that can help you understand your statements and better hold your advisor accountable when it comes to performance reporting.
North American Securities Administrators Association: Understanding Your Brokerage Account Statements (http://www.nasaa.org/wp-content/uploads/2011/08/SIFMA-SIPC-NASAA-Broker-Statements-Brochure.pdf)
U.S. Securities and Exchange Commission: Information for the Individual Investor (http://www.sec.gov/investor)
*a version of this article first appeared on this website July 31, 2015