An Easy Way to Become a Better Investor: Change the Way You Measure Your Performance

If it’s one thing I realise most about new investors, it is that they hardly ever measure their investment returns in percentage terms.

Most of them will make statements such as “I earned S$2000 from my last investment,” or “The mutual fund I invested in has given me S$3000 in profit.”

Although it is always nice to see your investments making a profit, the two statements above tells us nothing about how much you started with nor how long it took for you to earn those profits.

This is important because taking 10 years to earn a $2000 profit from a $200,000 investment is actually a horrendous result – you’re making a cumulative return of merely 1% after 10 years!

So, there has to be a better way to measure returns and this brings me to how most experienced investors calculate their performance – they do so in percentage terms on an annual basis. Here’re the advantages of doing so:

1. It’s easier to compare how you are doing in relation to the broader market. In Singapore’s context, this could mean comparing your returns with that of the SPDR STI ETF (SGX: ES3), an exchange-traded fund which tracks the market barometer the Straits Times Index (SGX: ^STI).

The implication of doing so is that if our own investments are giving us poorer returns than the market, we might want to consider investing in an index to achieve a market-like return instead.

2. It’s easier to estimate how your wealth will grow in the future if your return is consistent.

3. It’s easier to compare the performance of each individual stock to your whole portfolio. That way, you can have a better idea of what your best winners and worst losers look like so that you can learn lessons from them and become a better investor.

4. As a bonus, there’s no need to disclose your actual wealth and profit to outsiders.

Let’s now move on to how we can calculate returns on an annual basis. For example, if you earned S$1,000 over the past two years from an initial investment of S$10,000, you would have achieved an annualised return of 4.88%. The mathematics work as such:

{[(Profit + Starting Capital) / (Starting Capital)] ^ (1/Number of years)} – 1

With the numbers slotted in, the formula looks like this:

{[(1,000+ 10,000) / (10,000)] ^ (1/2)} – 1 = 0.0488 = 4.88%

If you have doubled your starting capital over say eight years, that would mean you have achieved an annual return of 9%. You can punch in the numbers using the formula above to obtain the 9% result, or you can calculate this from the rule of 72 as discussed here.

Once you start viewing your investment returns in percentage form, you will realize that you do not really need an extremely high return (such as 30% a year) in order to achieve a great result at the end of it all. A simple and non-flashy 5% return a year can still help compound your wealth significantly if you manage to do it over decades.

Foolish Summary

Before we start worrying about which investment to buy and how to construct our portfolio, an easy way to become a better investor is to start by looking at our investment results the right way – in percentage terms on an annual basis.

In this way, we will not be easily tempted to make rash decisions and would be able to logically compare different investments in terms of their true performance.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn’t own shares in any companies mentioned.