You Might Not Have 'Beat The Market' in 2010

It’s important to determine if your fund managers are earning their keep.

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Retirement investors are faced with two basic investment choices: pay high fees for professional mutual fund managers to beat the market (called "active" investing) or buy low-fee funds that simply own all of the stocks in a given group ("passive" investing). If you have an actively-managed portfolio, it is important to determine if your fund managers are earning their keep.

First, understand that 2010 was an excellent year in the stock market. Everyone should have made money. But did you make enough money to compensate for the risks you took? Here's a way to figure out that answer.

[See 5 Things You Should Do for Your Investments Now.]

The common wisdom is to use the Standard & Poor's 500 stock index as a gauge to measure market returns and determine if you "beat the market." But if you have a well-diversified retirement portfolio and own small-, mid-, and large-cap U.S. stocks, international stocks, real estate, bonds, and even commodities, the S&P alone is insufficient; it is only one of several indices of your portfolio. Judging a diversified portfolio's returns just by the S&P is like grading a salad just by the lettuce. A salad is made up of many ingredients—and so is a portfolio. You have to measure the interplay of all components to find out if your portfolio achieved "market" returns. Sophisticated investors don't judge their returns by the S&P. They look at how well each component performed against a benchmark.

To measure your portfolio's results with a true apples-to-apples comparison, you have to compare it with a portfolio that includes all of the indices in your portfolio. For example, if you had 50 percent of your money in S&P 500 large-cap mutual funds and 50 percent in bond funds, you would average the 2010 returns of the S&P 500 and bonds, and compare that with your returns. If you did better than the average of these two indices, then you did well.

Our 2010 Report Card presents returns for five model portfolios built with the standard asset allocations you'll find in most retirement portfolios. By using ultra-low fee exchange traded funds (ETFs) from Vanguard, iShares, and State Street, we take out the fees that you'll find in mutual fund portfolios, so we're left with "pure" returns. We then use all-ETF portfolios that include different allocations to all industry-accepted asset classes as "baseline" portfolios as a way to benchmark 2010.

[See 3 Rules for Positive Returns in 2011.]

For example, in 2010 a 90 percent bond portfolio should have gained almost 4 percent with extremely low risk. In the worst month, this portfolio lost only about 1 percent. Alternatively, a diversified 10 percent bond portfolio should have experienced a robust 16 percent rise by the end of the year. However, to get to that point, investors endured a loss of more than 6 percent in the worst month—a one-year swing of 22 percent!

To see how your retirement portfolio performed in 2010, use the instructions on our Report Card and compare it with one of our five passive low-fee portfolios. If you are paying fees for managers to actively pick stocks and manage your portfolios, you now can see if you are getting your money's worth. If you have a typical portfolio with these allocations that didn't achieve these results, you are underperforming and might want to make some changes.

Mitch Tuchman is CEO and Founder of MarketRiders, an online investment advisory and management service helping Americans invest for retirement. MarketRiders gives investors greater peace of mind knowing that they are leveraging the best thinking of Nobel Laureates and the investing methods used by the world's most elite institutions and wealthiest families. MarketRiders is on the investor's side, helping reduce investment costs and risks, and increasing retirement savings.