Apart from having absolute return targets, which may be too exacting because prices tend to fluctuate, sometimes wildly at that, the next best thing is to create a benchmark.

A benchmark is “a standard or point of reference against which things may be compared or assessed.” Your pinky finger is short if you compare that finger to other fingers on your hand (perhaps except for your thumb).

You can compare the performance of your equity investing by measuring your returns over a specified period to those of other equity investments with the parameters for investing (i.e. risk/return objectives, time horizon, currency, market focus, etc.). By this reasoning, it would be inappropriate to put performance of an actively traded fund side by side with that of an index fund in markets that are not efficient. 

Regardless of the process, individuals tend to under-compute their performance because they do not include the benefits of reinvesting cash dividends earned from their investments. 

Efficient markets are those, like the US market, where news is quickly reflected in prices and as such, no one can make above normal profits consistently.  In such markets, it would be difficult to outperform the broad market index. That is why index funds are recommended over actively traded funds in such markets. 

In the Philippines, the stock market is still on its way to becoming an efficient one. Proof of this is that funds can still outperform the broad market index.

More than having the same investing parameters, returns need to be measured in a comparable way. For example, cumulative returns are but simple or absolute returns that do not take into consideration the time value of money. Investment A’s cumulative return of 100% may be the same as Investment B’s cumulative return of 100%. But if Investment A earned its 100% return over five years, and Investment B earned its 100% return over 10 years, Investment A would be the better performer.

For the purpose of comparing returns, annual compounded returns would be the better choice especially for return periods over one year. An improvement over plain annual compounded returns, it computes the same for each investment in a portfolio and then applies weights on such returns by the size of investment (i.e. by market value).  Such a computation is ideal for an investment portfolio where periodic additions to and withdrawals from the portfolio are present.

Regardless of the process, individuals tend to under-compute their performance because they do not include the benefits of reinvesting cash dividends earned from their investments. Pooled funds such as variable unit-linked insurance (VUL), mutual funds, and unit investment trust funds (UITF), do away with this problem because they compute their prices and performance with cash dividends reinvested.

Here’s the thing; the benchmark for portfolios that reinvest dividends cannot just be the Philippine Stock Exchange Composite Index or PSEi because this index only computes price appreciation, without cash dividends reinvested.

To remedy the issue, the Philippine Stock Exchange (PSE) recently came out with the PSEi Total Return Index (TRI). To quote the PSE, “the PSEi TRI covers both price performance and income from dividend payments by reinvesting cash dividends according to their respective market capitalization weightings.”

Measuring your performance will be meaningful only if you apply the proper benchmark because it’s all about that base. For equity investing in the Philippines, it would be the PSEi TRI.  And to do away with your computing returns in a cumbersome way, just invest in equity pooled funds. You benefit from professional management as well.