Find the right yardstick before judging your performance results.
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By Christine Benz | 11-01-10 | 06:00 AM | Email Article

"Did I make 42% during the past year?"

That's what I found myself wondering when I read that savers in Fidelity 401(k) plans averaged a 42% personal rate of return during the one-year period through early 2010, according to a Fidelity report.

Christine Benz is Morningstar's director of personal finance and author of 30-Minute Money Solutions: A Step-by-Step Guide to Managing Your Finances and the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. Follow Christine on Twitter: @christine_benz and on Facebook.

Granted, that particular time period was extraordinary: The stock market bottomed on March 9, 2009, and the S&P 500 gained nearly 47% from April 2009 through March 2010.

Periods like that can inspire euphoria but also a bit of performance anxiety, prompting investors to question their approaches. If your fellow Morningstar.com user, sister-in-law, or the guy in the next cubicle can generate such good investment results, you think, what's wrong with me?

In a worst-case scenario, eyeballing others' performance can prompt investors to trash their investment strategies at the worst possible times. The technology stock bubble of the late 1990s provides a vivid case in point. Even professional investors jettisoned well-defined, valuation-conscious strategies because they were worried about matching the gains of the many Internet stock-fueled performance-chasers who had generated triple-digit returns.

Yes, using random performance measures to gauge your own acumen is isn't very helpful, and may even be dangerous. In most cases, you have no way of checking whether a boaster's claim is even true. Moreover, comparing your returns to someone else's doesn't take into account the fact that you and another person are apt to have different time horizons and asset allocations. Depending on the differences in your respective asset mixes, your own performance could be dramatically better or worse than someone else's at various points in time

How Am I Doing?
So what's a better way to see if your performance is on the right track and keep yourself from getting buffeted around by performance anxiety?

The first benchmarking method is so obvious that some investors blow right past it: Set a target dollar amount that you'd like to amass for a goal, such as retirement, and periodically check the amount you've saved versus that target. The virtue of such an approach is that it keeps you anchored in your own goals and needs, not someone else's. And if you periodically check on your progress versus your target, it will be pretty clear when you need to do more of the heavy lifting by saving more and spending less. (Unfortunately, too many investors underrate the importance of their own savings rates in achieving their financial goals.)

Morningstar's Savings Calculator provides a good way to gauge whether you're saving enough to meet your goals. T. Rowe Price's Retirement Income Calculator is another worthwhile tool for evaluating how much you'll need to save in order to support your income needs in retirement.

How Good an Investor Am I?
Staying focused on your results in absolute terms can be a good anchor. But it's also worthwhile to check up on how good an investor you are. The goal here is to monitor whether you're adding any value with your security selection. If you're not, you're better off opting for cheap index funds or exchange-traded funds and calling it a day.

For a view of how results stack up in relative terms, it can help to set up a custom benchmark that matches your own asset-allocation targets or the asset allocation of your portfolio currently.

To create a simple benchmark portfolio that mimics your own portfolio in terms of its asset-allocation mix, use Morningstar's Instant X-Ray tool to gauge your current exposure to each of the major asset classes--U.S. stocks, foreign stocks, bonds, cash, and "other" (usually convertibles and preferreds) then translate that into dollar terms. For example, if Instant X-Ray says that your portfolio contains 34% in bonds, 42% in U.S. stocks, 15% in foreign stocks, and 9% in cash, and your total portfolio is $1 million, your weightings would be $340,000 bond, $420,000 U.S. stock, $150,000 international stock, and $90,000 cash.

After that, click on Instant X-Ray from the Tools cover page of Morningstar.com. This time, start with a new screen for Instant X-Ray--separate from the screen where you entered your own portfolio holdings. Using index funds that correspond with each of the major asset classes, enter a new portfolio that reflects your own portfolio in terms of its asset allocation. (Enter "CASH$" for your cash holdings.)

Using the example above, the portfolio would consist of the following:

Then click Show Instant X-Ray and Save Instant X-Ray Holdings as a Portfolio. Name this one "Benchmark Portfolio." (Note: I used Vanguard funds for the benchmark portfolio because the firm's international index fund includes emerging markets, but you could easily use similar index funds or ETFs from other providers if you'd like.) Creating such a custom benchmark isn't time-consuming and can be invaluable when attempting to gauge how you're really doing.

A version of this article appeared on May 24, 2010.

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