I want to evaluate the performance of my stock market investments relative to a market index. However, I can't think of a good way to interpret the performance of my investments since I frequently transfer cash in and out of my brokerage accounts. Hence, my principal amount fluctuates drastically througout the year. I can demonstrate my dilemma with this hypothetical scenario here.
- Let's say that on Jan 1, the S&P500 was at $2000 per share.
- On Dec 31, the S&P500 was at $2240 per share.
- Thus, the S&P500 increased about 12% over the year. This calculation is nice and simple.
- Let's say that on Jan 1, I started my brokerage account and put $1000 in it.
- On December 29, my brokerage account showed $1200 in it.
- On December 31, I transfer another $1000 into my brokerage account. Now my brokerage account shows I have $2200.
- Thus, my brokerage account increased about 10% over the year.
When comparing these two scenarios over the course of 1 year, it clearly shows that the S&P500 outperformed my investing efforts in my brokerage account. But this doesn't seem right to me at an intuitive level. The only reason my brokerage account under-performed is because I injected new principal amounts that did not have time to appreciate in value. If I had transferred money the day after to start off the new year, then my brokerage account would have shown a 20% increase in one year, meaning I outperformed the S&P500 by a substantial margin.
This is a simplified scenario. In my actual brokerage account, my principal amounts have varied drastically throughout the year because I'm often moving cash in and out of the account.
Another scenario I thought about was comparing against the index month by month. But what if for 11 months, I beat the S&P500 by 0.01%. But then in one of those months, the S&P500 beat me by 200%. Clearly, barely beating the index for 11 months does not trump a substantial loss in 1 month.
How do people normally calculate whether they've outperformed particular benchmarks when there's a lot of fluctuation in the principal amount throughout the year?
Actually, I just realized maybe I need to equalize the environment for the two scenarios. If I want to compare against the S&P500, I need to consider this scenario:
- Let's say on Jan 1, the S&P500 was at $2000 per share, but I was able to buy HALF of it at $1000 after transferring $1000 into my brokerage account.
- On December 29, my brokerage account will show something close to $1120 because the S&P500 grew 12% in that year.
- On December 31, I put in another $1000 into my brokerage account and buy more of the S&P500 with it. Now my brokerage account shows $2120.
Now I compare my $2120 of this S&P500 scenario to my hand picked investment scenario of $2200. My hand picked scenario outperformed the Index.
Is that how it would be done? I'd have to compare the same actions but against different investment options?