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The Measurement Advantage

The ability to gauge how your investments are doing is crucial

Recently, an acquaintance told me that a couple of real estate investments he had made had done much better than his stock investments. Here are the details he gave me: around 1990, he bought two plots of land in Gurgaon, still a obscure small town on the Delhi-Jaipur highway, for a total of Rs three lakh. Almost two decades later, when the real estate sector was in its deepest panic late last year, he sold off both for Rs 67 lakh. By his own account, this was a distress sale. Nonetheless, he was quite happy at having turned his Rs 3 lakh into Rs 67 lakh.

He says that in sharp contrast, he had dabbled in a lot of stocks through 2004 to 2008 and only some of them did well. He had invested various sums of money ranging from Re 1 to Rs 5 lakh at various times and taken out different sums of money, some to invest again and some to use for other purposes. Some investments made very good gains, others turned out kind of OK and still others were losses. Currently, more than a year later, his lasting impression is that both his real estate investments did well, but only some of the stock investments did so.

After irritating my friend with far too many probing questions, I calculated that as far as one could make out, he had earned returns of 18 per cent per annum on his stock investments and about the same on his real estate investments. Of course, the two investments had vastly different time horizons, liquidity and manageability characteristics so they're not interchangeable, but the rates of return came as a shock to my friend.

The moral of the story is that you can't manage what you don't measure. This is an old adage of business management and one comes across it in many contexts. Unfortunately, few of us apply it to our investments. Oh, we do measure, but just the bare minimum. We know how much we put in and (sometimes) we know how much things are worth. When we sell investments, we obviously come to know how much we have earned out of them, but that's about all. The most crucial thing - the ability to know how well an investment is doing in a way that makes it comparable to other investments is hidden behind a mathematical fog for most of us.

Unless we can measure the returns that our investments are giving us, in a form that makes them comparable across investments, it isn't possible to know what is a better investment and what is not. The need to measure goes beyond just returns. When we were analysing my friend's portfolio we saw that almost all his losses in stocks came from being overly concentrated in just one sector (ironically, real estate). Even more interestingly, far more of his gains came from following the advice of one of the two brokers he was dealing with.

Such measurements and analyses are not difficult to make. The basic rates of returns just need paper, pencil and some formulae which one can either hunt up on the internet or learn from any eighth grade student who is good at maths. For detailed portfolio analyses, there are many websites including one which I can definitely vouch for, which is http://valueresearchonline.com. There's no excuse for allowing the fog of numbers to prevent you from knowing what is really going on with your investments.