As the onset of the New Year occasions the regular annual stock market reset, January is traditionally a good time for any stock market investor to “take stock” of one’s performance in the market relative to the major indices and relative to one’s own performance in prior years. More frequent evaluations of portfolio performance of course may also be helpful, though annual and longer evaluations are needed to allow for a sufficient longer-term perspective on performance that discounts “noise” caused by unrepresentative short-term gyrations. This is true for all investors. For Market FIRE investors who in whole or in part rely on their stock portfolio for ongoing ordinary expenditures, this is especially important. For such investors, annual recordkeeping to track portfolio performance is a useful and even necessary tool to ensure satisfaction of investment objectives and consider whether portfolio and other strategic financial adjustments and refinements may be appropriate.
Although the specific metrics that are used and emphasized may vary according to different investors, all Market FIRE-oriented investors should keep track of certain basic types of figures that take into account figures that capture overall asset values and annual cash flow. It is best to construct and maintain a spreadsheet in Excel or other similar computer program in order to keep track of these types of figures on an ongoing, multi-year basis.
After the basic figures for asset values and cash flow, the annual spreadsheet should include annual nominal and percentage gain or loss figures from one or more general major stock market indices. The spreadsheet should further factor into this information certain adjustments for the investor’s own personal stock market investment portfolio, which as discussed below may allow for different more finely honed types of assessments and comparisons. After this information is compiled and reviewed, a Market FIRE-oriented investor is then better situated to make strategic assessments about the investment portfolio for the New Year and possibly for New Years beyond.
I. Suggested General Asset and Portfolio Value Figures
Total Asset Market Value = Stocks + Bonds + ETFs + Mutual Funds + Long Options + Cash
At a basic level, the Market FIRE investor should consult the prior year’s beginning and year-end brokerage account monthly statements, from January and December respectively, to note on the spreadsheet the starting and ending total asset market value and net portfolio value. The total asset market value will be comprised of all stocks, bonds, ETFs, mutual funds, long options, and cash and cash-like holdings in the account. If there are multiple investment accounts, these figures should be aggregated.
Net Portfolio Value = Total Asset Market Value – Liabilities
The net portfolio value will consist of the value of all assets minus all liabilities, which in the Market FIRE context will likely be all outstanding short options, specifically the negative outstanding value of all covered call and cash-secured put options.
Separate figures on the spreadsheet should be maintained for some of the components of the portfolio. Specifically, figures should be noted for the starting and ending cash balance, starting and ending value of stocks plus long options held, and starting and ending value of short options.
The above framework separately calculates figures based on asset market value on one hand and net portfolio value on the other. These two branches of computation allow an investor to look at portfolio performance in two complementary ways. The net portfolio value may closely track the account balance figures provided as the “headline” balance figure for brokerage accounts; however, this may not be the most useful figure.
Net portfolio value provides a “mark-to-market” valuation of a brokerage account that indicates the dollar value of the account if all assets are immediately freed of liabilities and then simultaneously liquidated. Needless to say, it is extremely unlikely that ALL the assets in an account will ever be liquidated this abruptly. Using this valuation undervalues the monetary worth of a portfolio by essentially overstating the weight of covered call liabilities that — provided the conservative approach advocated by this website is followed — will almost always be diminished by time decay and overcome by the collection of greater amounts of premium over time.
So long as an investor intends to hold onto portfolio assets for the long term and diligently maintains the short options positions that are counted as liabilities against net portfolio value, then the total asset market value may offer a more accurate and holistic assessment of the value of the portfolio. Thus, it may be preferrable to emphasize review of actual and adjusted asset market value figures described herein when considering and comparing portfolio performance in isolation and compared to the market as a whole. To the extent that any covered call options have substantial intrinsic value and are “deep in-the-money,” then this asset market value should be discounted by most of the intrinsic value to the extent that an investor wishes to determine “actual value.”
In sum, as a general matter, a Market FIRE-oriented investor may gravitate more towards the figures based on asset market value. Figures based on net portfolio value still should be noted as indicators of “mark-to-market” value and of the overall proportion of liabilities relative to assets.
II. Suggested General Cash Flow Figures
Also at a basic level, on the market-based side of the cash flow part of annual recordkeeping, the Market FIRE investor should consult the separate spreadsheet maintained to keep track of monthly covered call and cash-secured put options premium — as previously described in the personal finance and budgeting sections of this site — and note on the annual spreadsheet the total aggregated figure for short options premium generated. As noted in the personal finance and budgeting section of this website, this figure may not always be equivalent to the total realized capital gains for short options reflected on an investor’s brokerage statement. Realized gains for options, as accounted for by brokerage companies, do not reflect premium generated for written options that have not yet been closed, despite the fact that cash has already been made available to the account holder. The investor’s own monthly records from calculating each month’s options premium thus may be the most accessible and accurate source of this information when aggregated for an annual figure.
Additionally, the investor should consult the year-end brokerage account monthly statement from December to note on the annual spreadsheet the total amount of dividends and interest earned for the brokerage account(s) during the calendar year. Along with short options premium, these dividends are the readiest source of cash funds that have been regularly available for personal living expenses.
For further cash flow description purposes, the Market FIRE investor should consult brokerage statements to determine amounts of realized gain from stocks, not including amounts realized through options, as well as amounts generated from sale of stock. Though perhaps a secondary source of cash for personal expenses in most market environments compared to short options premium, these sources should be separately noted on the annual spreadsheet as a portion of the available cash flow for personal expenses if the investor needed to draw upon them.
On the non-market, strictly personal financial side of the cash flow part of annual recordkeeping, the Market FIRE investor should consult the year-end brokerage statement from the month of December to note on the annual spreadsheet the amount of net cash deposits, such as those generated from part-time employment or freelance work or other types of business income, making sure to exclude from this figure dividends and options premium (which are accounted for elsewhere in the figures described in the previous paragraph).
Additionally, the year-end December brokerage statement(s) should be consulted to note on the annual spreadsheet the amount of cash outflows from the brokerage account, such as withdrawals used for ordinary living expenses, capital expenditures, and other non-stock investment acquisition costs. The combination of these cash inflows and outflows should also be separately noted on the annual spreadsheet. They will be useful later on in assessing annual portfolio performance when taking into account certain adjustments for the sake of different types of analysis that isolate certain factors.
III. Suggested Market Index Figures
Ultimately for eventual comparison purposes, the Market FIRE investor may want the annual stock market financial performance spreadsheet to include certain market index return data that reflects annual percentage gain or loss for each market index. For most investors, the S&P 500 index annual gain or loss is generally one that is appropriate to include, given that this index is the most generally accepted indicator of overall stock market performance, albeit one skewed towards large- and mid-cap companies. NASDAQ (with higher volatility) and Dow Jones Industrial Average (with lower volatility) information may also be appropriate for many investors, especially if the investor’s own portfolio includes a significant proportion of securities respectively from the industrial sector or the technology sector.
Information from other indices may also be appropriate for inclusion, depending on which indices could properly be considered as a benchmark for an investor depending on preferred types of companies represented in the investor’s portfolio. The annual performance of the Russell 2000 index, for instance, is appropriate if the investor’s portfolio includes a large proportion of small-cap companies’ stock. The FTSE Global or other international index should be used if the portfolio includes a large proportion of stocks from companies that conduct business primarily overseas in countries other than the United States. Other indices, among the many available, can be used as appropriate depending on the nature of an investor’s portfolio and the types of stocks held.
Total Return values for any indices represented in the annual spreadsheet should generally be used, so as to include the value of any dividends distributed by companies included in the index. Depending on the points of concern for the investor, market return without dividends may also be included but is not generally preferred over total return index figures. For whatever indices are selected for the spreadsheet, this historical information should be readily available via public sources on the internet.
IV. Appreciation or Depreciation in Market Assets and Net Portfolio Value
With the prior types of information having been compiled, it becomes appropriate to determine the appreciation (or depreciation) in market assets in the investor’s portfolio, as well as the change in net portfolio value. There should be basic calculations for both types of appreciation or performance included on the annual spreadsheet, but as described below in the next section there should also be adjusted calculations included to evaluate performance based purely on market factors without the impact of personal cash inflows or outflows.
The basic calculation for change in market assets will look at the difference in dollar value of the total assets in the portfolio (stock, bonds, ETFs, mutual funds, long options, cash, and cash equivalents) at the end of the year minus the dollar value of the same classes of assets from the beginning of the year. The same type of difference should be determined in net portfolio value by taking the dollar figure for the net portfolio value (assets minus liabilities) from the end of the year minus the dollar value of the net portfolio value from the start of the year. The total asset value and net portfolio value are both taken from brokerage statements as described in the first part of this article.
Similarly, the percentage change in market asset value should also be calculated by taking the annual monetary change in total asset market value by year-end divided by the figure for total asset market value from the start of the year. The percentage change in net portfolio value should likewise be calculated by taking the annual monetary change in net portfolio value divided by the figure for net portfolio value from the start of the year. The monetary change in value and percentage change for total asset value and net portfolio value should all be noted on the annual spreadsheet.
V. Adjusted Appreciation in Asset Market Value and Net Portfolio Value, In Order to Control for Dividends, Short Options Premium, and Impact of Non-Market Factors and Allow for Comparisons
Separate adjusted figures for asset market value and net portfolio value, as well as for appreciation in these levels, should all be computed, in order to control for the impact of the effect of dividends, short options premium, and non-market cash inflow and outflows. Although these calculations by necessity are imperfect representations of portfolio appreciation without these factors, they nonetheless can approximate the annual change in critical components of the Market FIRE investor’s portfolio, which in turn can be used to better assess performance of key aspects of the portfolio without distortion by the other factors.
One figure for adjusted annual asset market value appreciation should gauge the performance of only the amount devoted to stock and stock ETFs and mutual funds (and if applicable bonds and bond ETFs and mutual funds) held at the start of the year, without taking into account other additions to or subtractions from the cash position of the portfolio. This adjusted annual asset market value appreciation figure for initial stock may most readily be computed by taking the overall annual appreciation in market value for the portfolio minus net cash inflows (or plus net cash outflows) and minus dividends and short option premium. The same type of adjusted figure can be calculated for the annual net portfolio value appreciation, which is the same as above but also subtracts liabilities. Percentage changes for both adjusted figures also may be computed and placed on the spreadsheet.
Percentage Adjusted Appreciation Annual Asset Market Value for funds devoted to investments only =
(Annual Asset Market Value Appreciation – Outside Cash Inflows + Outside Cash Outflows) / Prior Year-End Total Asset Market Value
Arguably the key figure for adjusted annual asset market value appreciation is another variation, used to gauge the performance of only the amount devoted to stock and related investment assets held at the start of the year plus the cash generated from those assets throughout the year, namely dividends and short options premium. This adjusted annual asset market value appreciation figure may most readily be computed by taking the overall annual appreciation in market value for the portfolio minus only net cash inflows (or plus net cash outflows). The same figure can be calculated for the annual net portfolio value appreciation, which is the same as above but subtracts liabilities. Percentage changes for both adjusted figures also may be computed and placed on the spreadsheet.
VI. Use of Portfolio Annual Performance Figures in Reflecting on Market FIRE Investing Objectives
The compilation, review, and analysis of the information described above regarding annual portfolio performance allows a Market FIRE-oriented investor to gauge whether the portfolio is performing consistently with the goal of ongoing financial independence. These actions also allow a Market FIRE-oriented investor to determine whether adjustments to the portfolio may be appropriate to better maintain financial independence in the near future.
A. Total Portfolio Appreciation
At a basic level, it is preferrable when the value of any investor’s portfolio appreciates from an annual perspective rather than depreciates. With the various pieces of data noted on the spreadsheet, this total appreciation or depreciation should be readily discernible from the most recent and all prior years. An appreciating portfolio that was already of such a nature as to allow for financial independence should generally continue to be sufficient for financial independence if it has appreciated.
In order to determine whether a portfolio remains sufficient for financial independence purposes, it will be necessary to first look at total unadjusted portfolio asset market value, which will not correct for any net cash outflows devoted to living expenses in describing for year-end figures. After all, no matter how well a portfolio performed in relation to the market (a comparison that has its own value, as further discussed below), the actual annual change in portfolio value for an investor cannot help but be affected by the amount taken out for personal living expenses.
Of course, annual appreciation may not always occur, given frequent market volatility, including the occasional onset of corrections and bear markets, as well as unexpected developments within sectors or individual stocks that are emphasized in a portfolio at above-market levels. For purposes of this determination, appreciation also may not occur even if the adjusted investment portion of the portfolio otherwise increased, simply because the drag caused by withdrawals for personal living expenses may outweigh the impact of any appreciation due to market gains. If a portfolio depreciates in value, whatever the reason, it will need to be determined if the remaining market asset value is still above the pre-determined threshold for financial independence.
If the asset value declines below that level (generally between 7- and 10-times annual living expenses), then the investor should strongly consider seeking additional streams of revenue, such as part-time or freelance work, in order to supplement revenue from stock investing and options trading. The investor may also consider whether expenses can be trimmed so that the portfolio will be back on track for appreciation above desired threshold levels for financial independence. Additionally, depending on underlying market conditions, the investor may consider whether a different mix of underlying stocks — such as one with more volatility — should be placed in the portfolio so as to potentially allow for collecting greater covered call premium and leveraging that premium to acquire additional assets.
B. Cash Flow Sufficiency
Whether or not the year-end asset value is near or beneath an investor’s individual comfort threshold for financial independence, a Market FIRE-oriented investor should also evaluate annually whether and the extent to which the portfolio’s cash flow is adequate to serve both (1) the investor’s personal expenses and (2) the investor’s goals for acquiring additional investments in further stock.
As noted above, the primary figure pertaining to cash flow that may be used in making this assessment is the figure for short options premium. These are funds derived from short-term trades that generally may provide the most consistent source of revenue, under many if not most market conditions. To the extent that short options premium is not sufficient for the purposes noted above, then the figures on the spreadsheet for realized gains and overall revenue generated from stock sales will represent other cash flow sources.
This annual cash flow evaluation should have both retrospective and prospective value for the investor. If the cash flow from the prior year is deemed to be adequate for the investor’s needs and objectives, then that should be viewed as a validation of the overall cash flow strategy. If the cash flow was not adequate, then outwards cash flow should be recognized as having undermined the long-term stock principal in the investment account.
In the latter scenario, the investor will need to make strategic financial adjustments for the benefit of securing the integrity of future cash flow. Similar to the analysis for asset value, such possible strategic adjustments include seeking additional part-time or freelance work and using a different, potentially more volatile mixture of underlying stocks to use to write covered call options. In this scenario, the investor prospectively should also consider which long-term stock positions in the portfolio might be trimmed or sold completely in the near future in order to provide a source of further cash.
C. Market Benchmark Comparisons
Aside from portfolio appreciation and cash flow considerations in isolation, any investor should compare his own portfolio’s performance to one or more benchmarks represented by generally accepted market indices, usually the S&P 500 but also perhaps in conjunction with the Nasdaq, Dow Jones Industrial Average, and/or Russell 2000. As suggested in the section above, it is preferable for market comparison purposes to use the above-noted calculation for adjusted portfolio asset market value appreciation, which considers stock, long option, and cash value, including dividends and short option premium, but also subtracts any cash inflows from other revenue sources and adds back any cash outflows for personal expenses. This is because an investor’s portfolio does not perform better or worse relative to the overall market just because he either added cash from unrelated sources to an investment account or transferred out cash to pay for unrelated expenses.
Obviously, it is better to have one’s own investment portfolio perform better than the market indices. Since the stock market generally appreciates over time, a portfolio that earns outsized returns provides further support to the overarching portfolio appreciation and cash flow objectives for Market FIRE investing. But even in years of underperformance it can be helpful to recognize whether one’s own portfolio performance is at least correlated with at least one of the major market indices. As long as short options premium is regularly earned and the asset market value rather than net liability adjusted portfolio value is considered, the aim should be to consistently outperform the applicable benchmark(s). However, it may also not be unusual to underperform relative to a benchmark for one or two years. A longer-term, multi-year perspective should involve this comparative evaluation relative to market indices.
If underperformance is pronounced and not countered by other near-term overperformance in succeeding years, then more basic changes in a portfolio may be appropriate, such as selecting other underlying stocks that may more appropriately represent the cyclical mood of the macro-economy or embody secular trends in discrete areas of the micro-economy. More attention to individual stock quality may also be needed, such as through devoting more attention to accepted measures of stock valuation or analysis of their financial statements.
Whether a Market FIRE investor’s portfolio underperforms or overperforms relative to the market in any given year, the change in the calendar year should always occasion a review of the individual stocks in one’s portfolio. What may have worked in prior year may not work in the next year. Conversely, what did not work in the prior year may actually perform well in the new year. Most or even all stocks held in a portfolio may be appropriate for long-term holding, but even so some such stocks may deserve to be trimmed in the new year. These decisions should be made at least annually, and more likely quarterly to some extent, based on general considerations for stock selection, taking into account evolving macro-economic conditions, sector-specific circumstances, and individual company prospects.
HAPPY NEW YEAR!
Stock Market FIRE.com 
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