Personal Finance Best Practices

Your Wealth Glossary
Measuring Your Portfolio Performance
Provided by John Hamerlinck, UBS Financial Services Inc.
Published: February / March 2008

For many investors, the most important indicator of success is how well they are pursuing their long-term goals. Keeping track of investment performance is an important step in any investment plan. To fairly evaluate your portfolio, you and your financial advisor should determine how your investments have performed in relation to your specific goals and objectives; the general market environment and the specific market environment for the asset classes in which you are invested; the performance of other managers/investment objectives; and the amount of risk taken to pursue the return.

When evaluating your portfolio performance, comparing your results against the correct index can give an appropriate benchmark to compare against how your investments are performing. The Dow Jones Industrial Average, which is made up of 30 leading companies, is one of the best-known market indexes. Calculated by adding the prices of these 30 stocks and then dividing by the Dow divisor, which changes often, the Dow is typically considered a figure that indicates the general state of the stock market.

There is more to the stock market than just the “Dow”, however. Although that may sound obvious, it warrants comment for those investors who are disconcerted by the current ups and downs of the Dow Jones Industrial Average. Without negating the significance of these shifts for those who invest in the 30 stocks that make up the Dow, let’s review some of the major indexes from the perspective of investors with diversified portfolios. First, a few basics:

What Is an Index?
An index is a composite of securities designed to replicate the structure and performance of a specific segment of the financial markets. Market indexes are developed and used as comparative measurements for the performance of securities with similar investment style attributes. What all indexes have in common is that the value of the index changes proportionally to the value of the stocks in the index. So when the index goes up, the aggregate (or collective) value of the stocks in the index has grown by a proportional amount, and vice versa.

All indexes measure the performance of the markets or some subsection of them, usually on a continuing basis throughout each trading day. By tracking an index, or a variety of indexes, investors can help gauge market trends that may impact investment decisions. Indexes also function as benchmarks to compare the performance of the securities investors own against the markets in general. Although most investment managers use indexes as benchmarks, portfolios that are actively managed generally are not restricted to investing only in securities in the index. As a result, your portfolio holdings and performance may vary from the index. The past performance of an index is not indicative of future results and is not a guarantee of how your portfolio will perform. Indexes are not available for investment and reflect an unmanaged universe of securities, which does not take into account advisory or transaction fees, all of which will reduce the overall return.

What Is the Dow?
In 1896, Charles Dow compiled a list of 12 large U.S. companies to serve as an indicator of how well stocks in general performed each day. The average of the closing prices of the stocks was posted in a financial bulletin that he published with his partner, Edward Jones. The financial bulletin was the forerunner of The Wall Street Journal, and Dow’s list of stocks later evolved into the Dow Jones Industrial Average (DJIA). Today, the DJIA monitors 30 key industrial companies. It is the Dow Jones Industrial Average that is reported on television, radio and in newspapers during their daily stock reports.

There are also Dow Jones Utility and Transportation Averages, but when we refer to the industry average, it is the DJIA, or Dow, that we are talking about. The Dow is a price-weighted index, which means that component stocks are accorded relative importance based on the price per share of each stock. Consequently, higher-priced stocks have a greater percentage impact on the index than lower-priced stocks. If there is a sharp increase in the price of one of the stocks that make up the Dow, it can push the Dow index to highs while market capitalization weighted indexes might languish. Because of this, many observers question whether the Dow remains an effective market barometer.

More Measures than the Dow
Although the Dow may be the most widely reported index, there are others that measure many broader market sectors. There are indexes for domestic stocks, foreign stocks, large companies and small companies, domestic bonds, foreign bonds, long-term bonds, short-term bonds, etc.

If you have diversified your portfolio by choosing securities in various asset classes (stocks, bonds and/or cash reserves) and investment styles, you should not look exclusively at a general index like the Dow to fairly measure the performance of your securities. For the most accurate evaluation, you should view your portfolio in the context of each of the different asset classes or investment styles that it includes. There are indexes that can provide measurement for a very broad or a very narrow market segment. For example:

• The Standard & Poor’s 500® (S&P 500) index is a broader market measurement than the Dow, and more and more, is seen as the benchmark of the U.S. stock market – specifically for large company stocks. The S&P 500 tries to cover all major areas of the U.S. economy. The index does not follow the 500 largest companies, but rather the 500 most widely held companies – chosen with respect to market size, liquidity, and industrial sector. The S&P 500 is a market capitalization weighted index, which means that each stock is weighted according to the total market value of its outstanding shares. Therefore, the stocks of larger companies have a greater impact on the performance of the index than the stocks of smaller companies.

• The NASDAQ Composite Index® includes over 3,000 stocks. Most are technology and Internet-related, but there are financial, consumer, biotechnology and industrial companies as well. The index covers all the stocks that trade on the National Association of Securities Dealers Automated Quotation System. Brokers get price quotes through a computer network and trade via telephone or computer network. Since there is no centralized exchange, NASDAQ is sometimes referred to as the over-the-counter market, or a negotiated market. Like the S&P 500, the NASDAQ is a market capitalization-weighted index, so the larger companies tend to dominate the index.

• The Russell 3000® Index is considered a broad market index and follows the 3,000 largest American stocks. Started in 1984, it includes only common stocks within the U.S. and its territories. This market capitalization-weighted index can be subdivided into two segments: the Russell 1000 and Russell 2000 (see below).

• The Russell 1000® Index monitors the 1,000 largest U.S. companies. The companies in this index range in size from $1 billion to more than $300 billion, based on market capitalization. The index is highly diversified, as its component stocks represent all the major sectors. Although the Russell 1000 Index represents one-third of the stocks monitored by Russell, it accounts for approximately 92% of the value of the Russell 3000. This is a commonly used indicator for the U.S. large company stock investor.

• The remaining two-thirds of the companies monitored by Russell comprise the Russell 2000® Index. The Russell 2000 is considered representative of U.S. small- company stocks. The value of these stocks represents the remaining 8% of value of the Russell 3000. The Russell 2000 is reconstituted annually to help ensure larger stocks do not distort the performance and characteristics of the small company set.

• The Morgan Stanley Capital International (MSCI) EAFE® Index (Europe, Australasia, Far East) is considered a popular benchmark for following international stocks. It is composed of over 900 securities and consists of the following 21 developed market country indexes: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Greece, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland and the United Kingdom.

If you want to measure the benchmark performance of fixed income securities, you have another universe of indexes from which to choose. A fixed income investment should be compared to the appropriate bond index depending on the type of security and its maturity. For example:

• The Lehman Brothers® Aggregate Bond Index is used to track U.S. bonds as a broad asset class, and is made up of investment-grade, fixed-rate treasuries, corporate bonds, mortgage-backed and asset-backed securities. All bonds in the index should have a maturity of greater than one year, have at least $100 million available to investors, be publicly issued, and be U.S. dollar-denominated and non-convertible (which means that the bond cannot be converted into a stock).

• The Citigroup World Government Bond Index is a frequently used benchmark for tracking international bonds, although it does include U.S. securities. The index is composed of government bonds with an average maturity of seven years. It includes the 20 government bond markets of Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, the United Kingdom and the United States.

Note: Indexes are not available for direct investment and reflect an unmanaged universe of securities. All data in this article is as of January 2007.

The information contained in this article is based on sources believed reliable, but its accuracy cannot be guaranteed. This article is for informational and educational purposes only and should not be relied upon as the basis for an investment decision. Consult your financial advisor, as well as your tax and/or legal advisors regarding your personal circumstances before making investment decisions.

This article was provided by John Hamerlinck, financial advisor for UBS Financial Services Inc. Drawing on 20 years of management and financial experience You can contact John at 727-892-2516 or www.ubs.com/fa/johnhamerlinck.

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