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Two Views of the Same Investment…

How do you determine if your investment portfolio is performing well? If you are like many investors who are not full time professionals you will likely use some criteria external from the fundamental workings of the business or investment because you don’t have time to fully investigate or inspect each investment.

View #1 – Investment Market Value

By far the most common measurement is called market value. This is a single number that is the dollar value of all your investments if you sold them all at once at one point in time. If the market value is higher than what you paid for your investments, you made money. If the market value is lower, then you lost money. Of course these differences are on paper, because you never actually sold anything.

The market value is usually reported over multiple time frames. As an investor, you want to earn money sooner rather than later, so you need to know how much your investment changed during specific time periods.

When you open up your quarterly investment statements, the broker/investment firm will prominently display your ‘market value’ and a few calculations on your investment return which tells you how much the portfolio changed over the quarter or past year. This type of reporting is simple and to the point. It boils down all the changes (buys, sells, income, reinvestment) into an easily reported number.

View #2 – Investment Income

The measurement that we will primarily use here at @FinancialPlan is investment income. All of our investments here will earn income. So, to evaluate your portfolio over, say, a quarter the questions we ask are:

  • How much money did we make.
  • How much did it (increase/decrease) over the last quarter.
  • Was there any change that occurred in individual investments that might require us to make a change (investment decreased/increased income, buying/selling opportunity based upon market dislocation).
  • How should we allocate the money we made to new or existing investments?

Case Study – Realty Income from 2005-2009

In the IncomePort, we own a real estate investment trust (REIT) call Realty Income (O). As a REIT, the business model is simple to understand. They own a diversified set of commercial properties from which they collect rent. Each month they pay out most of the income from these properties to the shareholders.

As a simple income producing investment, one would think that the market would have a good understanding of its value and price it accordingly. However, over the years the market has chosen to value this company (its market value) all over the place.

Consider the following investment in Realty Income (O), from 2005-2009:

  • At the beginning of each year, you invest $500.
  • At the same time, you reinvest all the income from the previous year into additional shares.
  • At no point did you sell any shares.

How did this investment work out?

View #1 – Market Value Performance

At the beginning of 2009, you would have owned a total of 124 shares. The table below summarizes your investment. Unfortunately for you, every single share you bought was at a higher price than its January 2009 price. This means that if you sold the shares at that time you would have lost money.

Year Investment # Shares Market Value
2005 $500 21 $500
2006 $500 45 $1010
2007 $500 67 $1818
2008 $500 94 $2133
2009 $500 124 $2750
Total Invested $2868
Gain/Loss ($118)

View #2 – Income Performance

There is no difference here, you still own 124 shares. The tables below show what happened from an income view.

Year Investment # Shares Monthly Income
2005 $500 21 $2.48
2006 $500 45 $5.69
2007 $500 67 $9.18
2008 $500 94 $13.35
2009 $500 124 $17.74

Initially, this investment will pay you about $2.50 per month (the company pays its dividends out monthly). During the month of January 2009, you will be earning almost $18 per month. Pretty good, but most of this improvement was due to to fact that you reinvested more money. However, the other story here is that the company raised its dividend every quarter over those 5 years. So, even the initial $500 investment saw its income increase from $2.48 → $3.06 per month (23% increase).

Another way of looking at this is that the dividend yield increased from 6% to almost 7.5% per year.

So, even though the market says you ‘overpaid’ for your shares, from an income point of view, you are making more money every month.

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