It’s the Season for Your Portfolio Check-Up!

By Nancy Zambell, BrokerAdviser.com | Dec 17, 2007 | comment

Happy holidays, friends! We here at Financially Fit wish you the happiest and healthiest of holidays. And while we know you are most likely in the throes of making cookies, planning family get-togethers and buying presents, we just want to give you a little nudge to remind you that there is one more end-of-year task you need to take care of—performing a check-up on your investment portfolio!

Buying stocks, bonds, funds and exchange-traded funds is often akin to coming down the stairs on Christmas morning and finding lots of presents from Santa. Sometimes, even when it's time to sell them, we don't mind too much (especially if we've made a lot of money on them!) But, when it comes to keeping up with our portfolios and making sure that they still meet our needs, many of us would rather take a trip to the dentist!

Yet, it's imperative that we monitor – on a regular basis – the allocation of investments in our portfolios, how they are performing, and whether we need to make any changes to stay true to our goals. I've heard from too many investors who fail to do so and end up with nasty surprises because of their neglect.

The good news is that this process doesn't need to be complicated or time-consuming. It just requires a little thinking and a bit of research to make sure your investments are still performing as you need them to do.

So, let's get started!

The first step is to consider your personal circumstances and rethink your financial objectives. Have you married, divorced, become a grandparent, retired, bought a new or second home, bought or sold a business, or suffered any health setbacks? In other words, does your current personal situation require any significant changes to your long-term investment strategy?

Next, you need to take a look at your asset allocation, which is simply how your portfolio is apportioned among the stocks, bonds, cash and other investment assets you own.

In order to maximize your asset allocation, you will need to consider the timing of any future withdrawals from your portfolio.

For example, if you know that you have specific short-term needs, money you will require within the next 12 to 24 months, you'll want to make sure you have sufficient resources allocated to safe investments that have little or no risk to your principle. These investments include cash, money market funds, certificates of deposits and U.S. Treasury Bills. However, know that these investments come at a price – their returns – in the long-term, generally will not keep up with market performance or even inflation and taxes.

For intermediate term financial needs (usually 3-7 years), bonds may be a good choice. Their returns – over the long-term – also will generally lag the equity markets, but for shorter periods, they often provide positive, albeit moderate, returns. However, bonds—unless they are U.S. government instruments, do carry a risk to principle, so they are not 100% guaranteed.

Equities are generally the investors' instruments of choice over the long-term. Historically, they provide the highest returns, but also, come with the largest potential for principle losses. However, the longer you hold them, the greater chance you will have for positive returns—and usually, returns that will outpace cash or fixed-income investments.

For example, according to the Federal Reserve database in St. Louis, from 1928–2006, U.S. equities returned an average of 11.77% annually to investors, while the average returns for T-Bills and T-Bonds were 4.90% and 5.20%, respectively.

Should you be actively saving for retirement (and you all should), you will need to determine if your strategy will ensure that you have adequate funds to live your golden years in a truly golden manner. Too many folks put their heads in the sand and too late, arrive at retirement without enough resources to see them through what should, arguably, be the best years of their lives.

Most current studies recommend that retired investors withdraw at least 4% to 5% of their portfolios, annually, in order to maintain their current lifestyles. So that means you will need to make sure that your funds will tolerate that rate of withdrawal and last throughout what, hopefully, will be a long and rewarding period of retirement.

In my Financially Fit issue dated October 19, 2006, I wrote about several websites that can help you determine the amount of money you will need in retirement. I recommend that you take a look at some of the sites to help you design your retirement strategy.

http://www.brokeradviser.com/article.cfm?ID=17

Now, once you have determined the withdrawal requirements of your portfolio, you also need to consider your personal risk tolerance. That simply, is a measure of how well your investments will allow you to sleep at night.

Investments rise and fall, and sometimes they rise and fall a lot. So, if you can't live with a large degree of volatility, you may want to stack your portfolio with more conservative investments, such as cash and fixed-income instruments. However, as I noted earlier, you will most likely significantly reduce your potential returns. And that is a two-edged sword. Not only will your appreciation and income from your portfolio be reduced dramatically, but a portfolio of strictly conservative investments may not grow enough to allow you to retire when you want to, or to attain the kind of retirement lifestyle of which you have dreamed.

As well, your risk tolerance will most likely change as you grow older and have different financial goals. Younger investors, on average, can afford to take much greater risks with their investments than those of us nearing retirement age.

As you are considering how to allocate your assets and what risk level you are comfortable with, you must also remember to adequately diversify your portfolio. That's the “don't put all your eggs in one basket” strategy. After all, some investments will do very well in different stages of economic cycles. And in others, they won't fare so well.

For example, energy and international stocks have been the ‘hot' areas for a couple of years, while financial stocks have recently taken a beating. But that won't always be the case, and investors who keep a disproportionate share of their portfolios in energy and international stocks are taking a big bet that those sectors will continue to outperform over the next few years. All you have to do to understand this risk is remember what happened to the tech investors of the late 1990s when 2000 rolled around. Those ‘can't-miss' stocks devastated many an investor's retirement dreams.

However, it's pretty difficult for the individual investor to perfectly time just when is the right and wrong time to get into and out of specific investments. Consequently, their portfolios often suffer from having too much in one area. As a result, you want to make sure that you have not over-invested in any one company or sector. It's best to diversify among companies, industries, as well as different market caps. Your portfolio should contain some small, medium and large companies in different sectors.

In addition to ensuring that your portfolio is diversified and allocated properly, you will need to also periodically review the performance of your investments to determine if they are keeping up with the market, as well as the financial goals you have set for your portfolio.

Of course, I am a committed long-term investor, so short-term fluctuations don't rattle me too much. Although, having said that, it is imperative that you know why your investments are down or up. If the rest of your company's industry or the entire market is falling, you can't reasonably expect that your shares are going to rise. If, however, your company's industry is doing well, and your company's shares are not, you will need to investigate the reason for that. That means keeping an eye on the financial reports and news releases issued by the companies in which you invest.

Once you've determined that your company isn't in dire financial straits, it is best to focus your attention on its longer-term numbers— its return over the past three and five years relative to its peers.

You should look at these numbers at least on a quarterly basis, but generally, you will find that you only need to change the mix, or rebalance your portfolio every 12 to 18 months. Financial planners typically tell their clients that the best time to rebalance is at year-end, when you can offset capital gains against any losses in your portfolio. But the year-end brings many obligations, so my advice is this: Whenever it's convenient for you will do, as long as you do it on a regular basis!

By taking a few hours every now and then to review your holdings, you will save yourself many headaches and probably a lot of money, over the long-term. This little bit of time will help you avoid major problems and ensure that your portfolio and your long-term goals consistently match.

So, make the time for this important undertaking. If you are too busy right now, at least schedule a date today, and then rejoice in the holidays and the warmth of your friends and families!

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