Chances are pretty good that your investments did well last year since the markets were up overall. The question is, what should we consider "good" performance?
In order to be able to answer that question, you first need to look at how you really did. If you have an investment account that you didn't put any money into or take money out of last year, then the answer's fairly simple. Look at the balance at the beginning of the year and the end of the year and calculate the percentage difference. (We'll have to look at the more complicated cases where a significant amount of money was going in and out of your investment account over the course of the year in another post).
Some people make the mistake of just looking at their current unrealized gains on the stocks they hold. For example, if you keep track of your portfolio on something like Yahoo Finance, you can instantly see how much the stocks you hold have gained. The problem is it doesn't tell you how it performed over a particular time period. So, the gains could have come from a couple of years ago, and your stocks could have stagnated last year, but you can't tell that from just clicking on your portfolio on Yahoo (or most other popular portfolio sites).
So, you've calculated your gain for 2006. Say it was 12%. Is that good? On the surface it sound good, but the questions should really be how did you do compared to the market overall? If the market soared 20%, then getting 12% in that year isn't very good. So how did the market do in 2006? Probably the most popular benchmark is the S&P 500 index. It's an index of 500 large U.S. companies picked by a committee at Standard and Poors. So, it isn't really the whole market, or even the whole U.S. market, but since it represents a large slice of the total U.S. market cap, it's a decent proxy.
Last year, the S&P gained 15.79%, so you can see that 12% isn't anything to brag about. Furthermore, there are other broad indexes that performed better. A GREAT chart to look at is this one by Callan Associates. This chart shows how different indexes have performed over each year since 1987. The color coding helps you to see how different categories vary considerably in relative performance from year to year. It highlights the uncertainty of investing in various segments.
For example, you can easily see how from 1995-1998, the S&P 500 Growth Index (a subset of the S&P 500 that focuses on growth stocks, such as Microsoft, Cisco, etc.) came in first every year (remember the Internet bubble?). Then, ever since 2000, it's come in second last every year. This illustrates the danger of looking at past years' performance and extrapolating it into the future. Back in the late 90's, it looked as if S&P 500 Growth stocks would continue going up for the long run. As the last 6 years have shown, that would have been a costly assumption.
Getting back to the question of how you really did last year, you should also consider how you would have done compared to other benchmarks. For example, how would the 12% have compared to MSCI EAFE (a index of International stocks from developed countries)? The MSCI EAFE went up 26.34% last year. So, without picking individual "winning" stocks internationally, you could have had close to 26% gains buy going with a mutual fund or ETF that tracked the MSCI EAFE (I say close to 26%, because there are some fees and transaction costs that cause index funds and ETFs to generally trail their benchmarks buy a small amount).
To sum it up, to really gain an understanding of how you did last year (are you really a stock picking genius?), you need:
- Accurately calculate your performance investment for the period in question (taking into account cash inflows and outflows).
- Compare that gain to a benchmark rather than an arbitrary figure (like 10%).
- Compare that gain to other benchmarks as well, to consider whether you would have done better had you been diversified into other categories of the stock market.
