What Is the Market Value of an Investment Portfolio, and Why Does It Matter?

The market value of something is how much the market would pay you for that item. This could apply to anything you own such as your house, car, camera, etc. Similarly, the market value of an investment portfolio is the amount of cash you would get if you sold all of your investments today.

Why Portfolio Market Values Are Important for Performance

Most performance books and articles start with this basic formula for calculating a return. However, they don’t explain what a beginning market value is, what an ending market value is, or how they are calculated.

It’s important to understand what these are, since market values are essentially driving the return – just look at the above formula.

What Are Beginning and Ending Market Values?

You will notice in the above formula that there are actually two different types of market values – a beginning market value and ending market value.  Let’s see what the difference is.  But remember, the core definition of a market value is how much you could sell your investments on a certain day.
  • Beginning market value: what your investments were worth (what they could have sold for) at the start of the return time period.
  • Ending market value: what your investments are worth at the end of the return time period.
So, for example, if you are trying to measure the return of January 15th, what would the beginning and ending market value be?
Well, the ending market value would be what the investments are worth at the end of the day of January 15th. The beginning market value would be what the investments are worth at the beginning of the day on January 15th.
But, wait! The beginning market value is a little more complicated than that. Typically, investment systems only store one market value – the market value at end of the day. So how do you get a beginning market value for the 15th?
They use the ending market value from the prior day as the beginning market value. So in our example, the ending market value on January 14th is used as the beginning of day market value on January 15th.
Phew, that was a lot.
But just a heads up that the next part of the post explains how a portfolio software system calculates a market value behind the scenes. For individuals who are just reading this to understand the basics of performance, you may want to skip the rest and move to another post such as cash flows.  For those who want or need to know this, please read on.

How Do You Calculate Portfolio Market Values?

If you’re a person investing on your own, you will typically use a brokerage company like Fidelity or Vanguard. Companies like that will have a software system that calculates your market values for you which you see when you log on to your account.
Large institutions like a university will typically hire an investment management company to manage their investments for them. The investment management companies will have software to calculate their investment market values.
The software used to calculate portfolio market values are called “portfolio accounting systems.” Portfolio market value calculations are a form of accounting. Similar to other accounting software, these systems usually calculate a market value via what is called a “Trial Balance” or “Ledger”.
Don’t worry if this scares you, this is not an accounting site! I am NOT an accountant, so I am not going to get into the typical accounting topics like debits and credits. My goal is to teach high level concepts so you understand what is behind the market value calculation. Why? Because if you really want to understand performance calculations, then you should know what is behind a market value.
So let’s go back to the trial balance. The trial balance will have “accounts” such as cost of securities, unrealized gain/loss, settled cash, payables, receivables, and accruals. Again, don’t worry if you don’t understand these accounts yet. We will get to them. But let me show you a photo for those of you who are more visual.
These accounts are summed to calculate the total portfolio market value.
In the rest of this post, my aim is to show you:
1.    What each of these accounts mean.
2.    Calculate a total portfolio market value by summing these accounts
3.    Calculate profit or loss of the total portfolio
4.     Calculate the return on the portfolio

P.S. In other pages of my site, such as the profit and loss, purchase, sale, you’ll see how specific transactions affect these accounts and therefore, how they can affect the return.  This post will only give you one example, but my site aims to show you the effects of all transactions on these accounts.

What Do Each of These Accounts Mean?

* For more information on cash, please read this post.

How Do You Calculate the Total Portfolio Market Value By Summing These Accounts?

I’m going to explain by using an example.
Imagine that at the end of the day, you hold a portfolio of the following:
Stocks
Stocks are currently valued at $100,000 (They cost you $90,000, and since they are now worth $100,000, it means you have an unrealized gain of $10,000.)  An unrealized gain means that you have gained money on the investment, but you have not sold it so you can still lose it if the market reverses.  Once you sell the investment, that gain is realized.
Bonds
Bonds are currently valued at $200,000 (They cost you $205,000 so you have an unrealized loss of $5,000).   But that’s not the entire picture because bonds actually pay you interest (coupons).
There are two things happening with the bonds in this example:
1)    The bond is losing market value based on its price.   Bonds can either gain or lose market value based on price similar to stocks.  In this example, the price decreases so it lost market value from this.
2)    The bond is gaining market value because it is accruing interest.
Portfolio accounting systems often maintain the bond market value in one account called “market value of bonds” or “market value of securities.”  Then the interest accruals are maintained in another account called “Accrued Interest.” The Accrued Interest account shows how much interest you have earned on the bonds so far.  In this example, we have $20,000 of accrued interest.  This accrued interest will change from something that is owed to you, to actual cash.
Cash
Typically investment accounts will also have an amount of cash in addition to investments.  For this example, I assume there is $10,000 of cash in the account, which is simply valued as $10,000, similar to when you have $10,000 in your bank account.  In the trial balance, it will show up as $10,000 in the “cash” account.
Your accounts would look like this:
Next let’s say over the next day:
·        The stocks gain $3,000
·         The bonds lose $1,000 in market value based on price changes
·         You gain $500 in interest from the bonds
·         There is no change to the cash balance
How would the trial balance account be updated to show these changes?  See below.

How Do You Calculate the Profit or Loss on the Total Portfolio?

The values from the trial balance above can be used to calculate the profit and loss on day 2.  Why day 2?  Remember, the total market value from the end of day 1 (the $330,000) will be the beginning market value on day 2.  The total market value from the end of day 2 (the $332,500) will be the ending market value on day 2.
So, for day 2:
·         Beginning market value of $330,000
·         Ending market value of $332,500.
The profit or loss (also called gain/loss) is calculated by looking at the change in market value:
Profit or Loss = Ending Market Value – Beginning Market Value
Profit or Loss = $332,500 –  $330,000 = $2,500
Please note that in this example we did not contribute or take any money out of the portfolio so the formula above did not need to incorporate that.  Please see the cash flows and Profit and Loss page for more details on this calculation when there are flows.

How Do You Calculate the Return on the Total Portfolio?

You will use the profit or loss from the prior step to calculate the return.  You want to see how much did you make or lose, over how much you started with.  So the return will be calculated as:
Profit / Beginning Value = 2,500 / 330,000 = 0.76%.
Look at that!  All the portfolio accounting data from the trial balance was used to get the $2,5000 profi, the $330,000 beginning market value, and the .76% return.
To summarize, in order to understand the sources of your returns, you need to understand how the portfolio accounting system is calculating the market values. So to learn performance, you should learn a little bit of portfolio accounting.
Posted by / July 8, 2018
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