The old management adage, You Can’t Manage What You Don’t Measure is as accurate today as when first stated. I don’t know the origin of the quote, but it is sometimes attributed to W. Edwards Deming. The adage is so fundamental, it likely goes back further than Deming. If I were to modify the quote, I would add something to the effect — and do it correctly’

When it comes to portfolios, there is a lot to measure. First, there is the Internal Rate or Return (IRR) or for money managers, Time Weighted Rate of Return. Since I am not comparing portfolio to portfolio, the IRR is sufficient. Second, we need to select a benchmark. Vanguard’s Total Stock Market Index Fund, the VTSMX, is one option. For additional references the TLH Spreadsheet includes VFINX and VGTSX.

None of these broad index funds are considered completely appropriate benchmarks, since each of the portfolios tracked at ITA Wealth Management include asset classes that reside outside the three mentioned index funds. For this reason, I came up with a method to build a customized index for a portfolio. It is called the ITA Index. and it is found inside the ITA Spreadsheet. While not a perfect benchmark, it goes a long way toward measuring how well a portfolio is performing with respect to the Strategic Asset Allocation plan for the portfolio.

To come up with the ITA Index, one needs to hold at least one share of the ETF that represents a particular asset class. For example, I hold at least one share of DBC as a representative of the commodities asset class. The choice of the ETF representing an asset class or sector will vary from individual to individual. VEU represents developed international markets, VWO — emerging markets, VNQ — domestic REITs, RWX — international REITs, VOE — mid-cap value, etc. The details are found inside the TLH Spreadsheet.

Measuring risk or portfolio uncertainty is a third significant calculation. Most managers use standard deviation (SD) or mean-variance. While SD is useful in certain situations, it has the drawback of penalizing the money manager for volatility to the upside. As investors, we want volatility to the upside where upside is defined as performance in excess of the benchmark. This is also known as alpha. Money managers are seeking alpha and should not be penalized for achieving this goal. Instead of using mean-variance, inside the TLH Spreadsheet we use semi-variance. By using this calculation, the money manager is only penalized for portfolio results to the downside.

Tracking portfolio and benchmark performance as well as measuring portfolio uncertainty may be burdensome for many investors. However, think about the connection between management and careful measurement. If you want to know how well your portfolio is performing, some systematic measurement system is required.