« How to prioritize goals based on available monthly SIP amount? How do you measure the performance of an individual mutual fund? »

Are you running your own mutual fund? Is it doing well?

Posted on 06 Jul 2021
Author: Sayan Sircar

Tags: Portfolio Review

6 mins read
📢Get new post notifications on WhatsApp!

When you are investing in stocks directly, are you measuring your performance as a fund manager?

How to benchmark while investing or trading

Introduction

Direct stock investing (DSI henceforth), whether for short duration (day trading or swing trading) or for long holding period attract many people. DSI is nowadays very easy due to the proliferation of discount brokers, social media experts and overall information availability. Since the market bottom of March 2020, many new investors have come to the market on the back of the bull run that started in April 2020.

The alternative of DSI is investing in equity mutual funds which means that each DSI investor is effectively running their personal mutual fund. Since all mutual funds should be periodically reviewed, how do you review the performance of your personal fund?

This is important because the purpose of investing is to meet a goal and for that, it is important to know if you are doing as well as you should. It is common among investors to say that their investment has got 20% CAGR or 15% XIRR but is that better or worse than a benchmark? This post deals with a simple way to measure the performance of DSI. Once the calculation is done, it is up to the investor to make the rational choice of implementing whichever strategy makes more money consistently.

Costs of DSI

There are multiple costs of investing in stocks directly, some of which are known and measurable while the rest are not.

Taxes: Securities Transaction Tax (STT) and Capital Gains Tax
Brokerage: This is typically 20-100bps for full-service brokers and zero for discount brokers for delivery. All brokers however charge a certain fee for intra-day trades. Also, some brokers offer a low brokerage plan for intra-day trading that costs a flat fixed fee. This needs to be captured under costs
Strategy fees: Some trading strategies (like Smallcase or via Social Media/Email) charge a monthly/quarterly or yearly subscription charge. This needs to be captured against costs for DSI
Slippage costs: this happens when a strategy gets updated once markets close (like over the weekend), and it gets executed at a different price when markets open on the next trading day. Another way this cost occurs when the strategy uses fractional shares to calculate the weights and generates a signal but execution happens using integer shares
Tax-pass through: Mutual funds do not pass on taxes when they buy/sell stocks but the investor while any selling during DSI will incur long term or short term capital gains taxes

Did you know that we have a private Facebook group which you can join for free and ask your own questions? Please click the button below to join.

How to measure performance

The premise of measuring the performance of DSI vs. mutual funds is seeing if the profit in DSI after all costs is more than if the money was simply invested in the Nifty index or an equivalent Nifty/Sensex index fund. The choice of the index is not that important since it can be argued that for example DSI in small-cap stocks should be benchmarked against the Small Cap index which is nowadays investible via index funds. However, investing in a Nifty Index fund is the simplest thing any investor can do and is therefore good enough for the choice of the benchmark for DSI.

We will create a replicated portfolio like this. For every trade (buy or sell), we will take the pre-tax price of the trade (market price times shares) and calculate if the money was invested in the Nifty index (or Nifty index fund), and then how many units of the index would have been bought (or sold). The sum of the index units multiplied by the current price of the index shows the amount that would have been there if there was no DSI. Ideally, the investor should do whichever strategy gives higher profits: DSI or Replication consistently.

Human capital and the best usage of time

Growing wealth depends on both income and investments and is one of the axioms of personal finance. There is an intrinsic limit to the amount of time you can spend per day or week in your primary profession. If you know your hourly wage, and you should like this, you should also be aware that you cannot scale the denominator i.e. hours/day indefinitely. This leads to the concept of increasing human capital, where you are enhancing your skills and knowledge to increase your income - both active income from your profession and passive income from other sources.

Greatest returns come from human capital

If you are investing in stocks directly, either trading and investing, you are spending a good amount of time in that activity trying to get higher returns. You should consider if it will be prudent to divert that time to your profession instead to increase your income to get more capital for investing. Human capital is covered in more detail here: Your human capital, not investment returns, is your biggest wealth creator.

A worked out example

Example of replication portfolio

Here we have two stocks A1 and B1 that have been traded from 2015 to 2017. Brokerage is assumed at 1% of trade value (change it to what applies to you) and capital gains tax is included for sell trades. There is another field called Other costs for any regular costs like subscription or brokerage plan costs. The Nifty value/units columns have the replication values. We take the value of Nifty on that day and calculate the Nifty units bought or sold.

In the example, there is a ₹ 1,000 cost of executing the trading strategy.

As the table shows, profit in the case of holding the Nifty portfolio is ₹ 6,789 while that of the DSI portfolio is ₹ 5,550. This lower alpha (DSI minus Nifty) is made worse by the ₹ 1,000 execution cost so the DSI portfolio is worse off vs. the replication portfolio.

We show these calculations in the Excel sheet here.

If you get a positive alpha figure after costs then that is good news since you are beating the replicated portfolio. If not, you need to decide soon how long you are planning to continue with DSI before switching to mutual funds.

What's next? You can join the Arthgyaan WhatsApp community

You can stay updated on our latest content and learn about our webinars. Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.

To understand how this article can help you:

If you have a comment or question about this article

The following button will open a form with the link of this page populated for context:

If you liked this article, please leave us a rating

The following button will take you to Trustpilot:

Discover an article from the archives

Worked out case studies for goal-based investing

Case study: how can this middle-aged investor with two children plan for retirement and children's goals?

This article shows how a single-income middle-aged couple with two small children reach their retirement and children’s goals.
Case study: can this double income single kid family reach FIRE at 50?

This article shows how a double-income couple with a 2-year old reach their FIRE dream at the age of 50.
Case study: how a family in their mid-30s with a newborn kid can FIRE and invest in real estate?

This article shows how a double-income couple with a newborn child can invest for their future goals of FIRE and real-estate investment.
Case study: how this double income recently married family can perform DIY goal-based investment planning

This article shows how a young just-married couple can invest for future goals using the Arthgyaan goal-based investing tool.
Case Study: How should couples in their 40s with a new baby plan their financial future?

Did you welcome a bundle of joy in your 40s? This article will discuss ways of planning the child’s (and your’s financial future)
Case study: how this double income single kid family can perform DIY goal-based investment planning

This article shows how a very typical salaried couple with one child can invest for future goals using the Arthgyaan goal-based investing tool.

Previous and next articles:

<p>What to do when goals do not proceed on track and not enough surplus is available for investing.</p>

Set Goals

How to prioritize goals based on available monthly SIP amount?

What to do when goals do not proceed on track and not enough surplus is available for investing.

Published: 5 July 2021

5 MIN READ

<p>Learn how to evaluate your active fund against a benchmark by combining return and risk</p>

Portfolio Review

How do you measure the performance of an individual mutual fund?

Learn how to evaluate your active fund against a benchmark by combining return and risk

Published: 15 July 2021

6 MIN READ

Latest articles:

<p>This article looks at the various stages of your career from the perspective of maximum wealth creation.</p>

Portfolio Construction

Which stage of your career is most important for wealth creation?

This article looks at the various stages of your career from the perspective of maximum wealth creation.

Published: 17 April 2024

4 MIN READ

<p>This article explains the new rules regarding income tax return verification which are now in place for tax returns to be filed 1st April 2024 onwards.</p>

News Tax

When should you verify your Income Tax return as per the new rules effective from 1st April 2024?

This article explains the new rules regarding income tax return verification which are now in place for tax returns to be filed 1st April 2024 onwards.

Published: 16 April 2024

2 MIN READ

Topics you will like:

Asset Allocation (21) Basics (8) Behaviour (12) Budgeting (12) Calculator (25) Case Study (6) Children (17) Choosing Investments (40) FAQ (12) FIRE (13) Gold (21) Health Insurance (5) House Purchase (28) Insurance (16) International Investing (12) Life Stages (2) Loans (17) Market Data (7) Market Movements (16) Mutual Funds (46) NPS (7) NRI (19) News (18) Pension (8) Portfolio Construction (52) Portfolio Review (27) Reader Questions (8) Real Estate (7) Research (5) Retirement (38) Review (15) Risk (6) Safe Withdrawal Rate (5) Set Goals (28) Step by step (15) Tax (59)

Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself.

Don't forget to share this article on WhatsApp or Twitter or post this to Facebook.

Discuss this post with us via Facebook or get regular bite-sized updates on Twitter.