As 2020 picks up, investors can look back on 2019 as an excellent year. While investors fretted about an impending recession in late 2018, those worries abated in 2019 and global stocks posted a tremendous rally.
Portfolio health is an important aspect of investing in the securities market. A disciplined investor can use an annual portfolio review as a way to check up on their portfolio -and potentially make some changes- within the context of their well-thought-out plan. This should be done regularly because, even if an investor hasn’t actively made changes to their portfolio mix, the contents of your portfolio may have shifted.
A disciplined investor can use an annual portfolio review as a way to check up on their portfolio -and potentially make some changes- within the context of their well-thought-out plan.
As an investor, think of this annual portfolio review as an inverted pyramid, with the most important securities on the top and the least important ones at the bottom. That way, if you run out of time and need to give something short shrift, you’ll have attended to the most important considerations first.
Here are the key steps to take:
Step 1: Conduct a ‘wellness check.’
Begin your portfolio checkup by answering the question: “How am I doing on my progress to my goals?”
For accumulators, that means checking up on whether your current portfolio balance, combined with your savings rate, puts you on track to reach whatever goal you’re working towards.Tally your various contributions across all accounts so far at the end of 2019: A decent baseline savings rate is 13.5%, but high net worth individuals might want to aim for 20% or even higher. Not only will high earners need to supply more of their cash flows with their own salaries, but they will also have more room in their budgets to target a higher savings rate.
If you’re retired, the key gauge of the health of your total plan is your withdrawal rate–all of your portfolio withdrawals for this year, divided by your total portfolio balance at the beginning of the year. The “right” withdrawal rate will be apparent only in hindsight, but the 4% guideline is a good starting point. (Remember: The 4% guideline isn’t about taking 4% of your portfolio year in and year out.)
Step 2: Assess your asset allocation.
Once you’ve evaluated the health of your overall plan, turn your attention to your actual portfolio. Take a holistic look at your total portfolio’s mix of stocks, bonds, and cash. You can then compare your actual allocations to your targets. If you don’t have targets you can always benchmark with the per industry average of your stock holdings.
Given stocks’ very robust performance in 2019, many investors’ portfolios are heavy on equities. That’s not a huge deal for younger investors with many years until retirement, but is a far more significant risk factor for investors who are nearing or in draw-down mode: Insufficient cash and high-quality bond assets to serve as ballast could force withdrawals of stocks when they’re in a trough, thereby permanently impairing a portfolio’s sustainability. If your portfolio is notably equity-heavy relative to any reasonable measure and you’re within 10 years of retirement, de-risking by shifting more money to bonds and cash is more urgent.
You could make the adjustment all in one go or gradually via a dollar-cost averaging plan. Just be sure to mind the tax consequences of lightening up on stocks as you’re shifting money into safer assets; focus on tax-sheltered accounts to move the needle on your total portfolio’s asset allocation.
Step 3: Check the adequacy of liquid reserves.
In addition to checking up on your portfolio’s long-term asset allocations, your year-end portfolio review is a good time to check your liquid reserves. If you’re still working, holding at least three to six months’ worth of living expenses in cash is essential; higher-income earners or those with lumpy cash flows (looking at you, “gig economy” workers) should target a year or more of living expenses in cash.
For retired people, we recommend six months to two years’ worth of portfolio withdrawals in cash investments; those liquid reserves can provide a spending cushion even if stocks head south or bonds take a powder. Retirees whose portfolios are equity-heavy can use re-balancing to top up their liquid reserves.In addition to checking up on the amount of liquid reserves that you hold, also check up on where you’re holding that money. A happy side effect of removal of the interest rates cap is that cash yields will trend up.
Step 4: Assess sub-allocations and troubleshoot other portfolio-level risk factors.
Most often, stocks of every persuasion seemed to move in lock step: Value stocks’ performance was in line with growth names, while small caps’ returns were in line with large. Not so for the past several years, as growth stocks like Safaricom have trumped value. Check your portfolio’s exposure and see if it’s tilting disproportionately to growth stocks. Not every portfolio has to be right on the top of the index with their holding average, but the exposure level lets you see if you’re making any big inadvertent bets.
Step 5: Review holdings.
In addition to checking up on allocations and sub-allocations, take a closer look at individual holdings. If you’re conducting your own due diligence, be on alert for red flags at the holdings level. For funds, red flags include manager and strategy changes, persistent under performance relative to cheap alternative investment funds, and dramatically heavy stock or sector bets. For stocks, red flags include high valuations and negative moat trends.
Holdings review, you can drop some stocks at the beginning of the year and accumulate some more or take a general overhaul of your portfolio. Investing in fundamentally stable stocks could be a best way to start off your journey this year!