How to gauge your book value and actual portfolio performance
By Raymond Letendre, CPA, CGA, CFP® 2 November 2022 5 min read
Evaluating investment performance is an important part of wealth planning. Like charting a course to a distant destination, navigating your path along the way is necessary to track progress towards your goal. How is this done, and where do you start? As an investor, finding your true north and plotting your course starts with the information found in your statements, including holdings, market value, and book value. However, if you’re judging performance based on the difference between book value and market value, you are likely underestimating your portfolio’s true performance. In this article we distinguish the correct use of book value, and a proper approach to measuring investment performance.
What is included in book value?
As the formula below shows, book value considers the cost of purchases and can change due to the impact of additional contributions, including reinvested distributions from the investment. This means that even if you do not make additional deposits to the investment yourself, the book value can increase over time as distributions are reinvested into additional units. This can lead to the appearance of underperformance if you’re simply comparing your market value to the stated book value.
Distribution of income
Identifying how hard your money has worked for you will require an understanding of your transaction activity, growth in value over time, and income distributions. Throughout a given year, investment funds may earn dividends, interest, and realize capital gains on certain holdings. The income earned is distributed to investment holders who may choose to take the distribution as a cash payment, or reinvest back into additional units of the fund. These distributions are taxable to the investor in non-registered accounts. So whether or not the distribution is actually taken in cash, it is considered to have been earned and paid to the investor for tax purposes.
Case study example
Let’s look at a simple example with Tariq who invests an initial amount and receives regular income distributions each year. Tariq funds his investment account by making an initial deposit of $100,000. At the end of the first year, he receives fund distributions totalling $3,000. Similarly, he receives year-end distributions of $3,500 and $1,500 at the end of the second and third years respectively.
Investment growth after 3 years
The chart above shows Tariq’s initial purchase of $100,000. Over the next three years, the market value fluctuated but has now grown to $110,000 in value as he also received annual distributions. Had he taken these distributions in cash, the book value would have stayed flat at $100,000. Instead, Tariq reinvested each distribution and saw book value grow from $100,000 to $108,000.
At the end of three years, Tariq might notice that the market value of $110,000 is barely above the book value and conclude that the fund has performed poorly, increasing only $2,000, or less than 2%, from the book value. This would be incorrect, and highlights the problem with comparing market value to book value, and why you should not rely on such a comparison to evaluate performance. To properly assess, Tariq should compare his own invested amount to the market value. In this example, Tariq's net invested amount was $100,000. Compared to the current market value of $110,000, total investment growth is $10,000, or 10% over three years. Therefore, the correct approach to determining total investment performance is:
Although there are also various time-weighted measures to evaluate performance, a simple approach for most investors can be thought of as all of the gains/losses in value plus income received. To find your total return, add the change in value from the time you purchased the investment to all of the income you collected from that investment in interest or dividends. To determine your return in percentage terms, divide the change in value plus income by the amount you invested.
If book value is not the correct benchmark for performance, then why is it included in my statement?
The short answer is taxation. In our article about how to calculate your capital gains and adjusted cost base, we explain that gains from the disposition of an asset are taxed as the difference between the proceeds of the sale, and the cost to acquire the asset. Most investment funds and pools will pay distributions at least annually and are taxable in non-registered accounts whether they are taken as cash, or reinvested. When distributions are used to purchase additional units, this is akin to a small contribution by the investor, and the book value will increase by the distribution amount.
With ongoing distributions, the cost base will increase every year that an investor elects to reinvest them. This becomes important when the investment is sold, as the distribution is considered in the adjusted cost base calculation and ultimately the capital gain calculation. Over time, these reinvested distributions can have a significant impact on the book value of the original investment.
- Good record-keeping is always a smart approach to planning and tracking investments. Be sure to maintain statements and related documents in a convenient location for tax reporting and investment reviews.
- Review and understand your account statements. Your account statement offers an in-depth picture of your account transactions, fees, and performance for each statement-to-statement period, including the total value of your account.
- T3 Statement of Trust Income Allocations and Designations, and/or T5 Statement of Investment Income will identify distributions paid to you.
- Be mindful of transaction fees. For a more accurate assessment, transaction fees incurred should be included in your calculation when you buy your investments. If calculating return on actual gains or losses after selling an investment, you should also subtract the fees paid when you sold.
- Consider the impact of taxes on investments. Computing after-tax returns is important for tracking progress, and taxation of various investment incomes can vary. For instance, dividends and realized capital gains are taxed more favourably than interest income.
- Consider the impact of inflation. With investments you hold for a long time, it's important to understand that inflation erodes your purchasing power and effectively reduces your investment returns. Your return adjusted for inflation or real return, involves deducting inflation from the return of your investment.
- Ask your advisor about performance during your regular reviews. Better yet, ask to have an analysis done through a planning engagement. This will focus on matching your qualitative goals with your quantitative results.
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