Face it, the last ten days have been the opposite of benign for investors. An unprecedented three years without a 10% correction ended abruptly last week. What can you learn about your portfolio from the market swoon. Quite a bit, it turns out. Here’s your checklist.
When we start working with new clients, we always take a close look at their existing investment accounts. Of course every portfolio is unique, but we routinely encounter six general flaws that hinder performance and increase risk. The next time you check your own accounts, see if you find any of these six danger signs.
- Lack of diversification. Most investors are significantly over-weighted in large cap US stocks, the name brands we all recognize. Healthy diversification means spreading money across many asset classes – stocks and bonds; large cap and small; domestic, international and emerging markets. The appropriate distribution across these categories depends on your age, financial situation, tolerance for risk and other factors. Remember, it’s all about you so expect customization in this important category.
- Too much stock in one company. A severe version of inadequate diversification is holding a large portion of wealth in one “special” stock. It may be stock in one’s employer (through a 401(k) or ESOP), or stock inherited from a loved one. Regardless of its source, a big concentration in one company is a giant red flag signaling unneeded and unwanted risk. You may believe you own the next Apple but the odds of that happening are close to zero when you look through the lens of history. Sorry, it’s true.
- High expenses. The financial industry does nothing better than extract fees, commissions and expenses from retail investors. We meet many investors who are unknowingly paying far more than necessary in expenses. Thanks to the 1000+ low cost ETFs now available, there’s no reason to do so. Don’t pay for what you don’t get and only pay for added value.
- Random asset location. Asset allocation is critical, but so is the location of assets across taxable and tax-advantaged accounts. Holding the wrong kind of assets in the wrong kind of account is an easy way to transfer wealth to state and federal governments.
- Tax indifference. We often find accounts with holdings that are underwater. These capital losses can be used to offset gains and reduce the annual tax bill. Losses can even be carried forward to future years. It’s free money, but it’s often ignored.
- Imbalance through neglect. Some portfolios start out great but deteriorate with age. This most often happens through failure to rebalance. Rebalancing distributes gains from best performing asset classes into others that have lagged. This maintains the desired asset allocation and avoids the risk associated with holding nothing but last year’s big winner.
These are not the only danger signs we see, but the most common. Is your portfolio waving any of these alert flags? If you’re not sure, we’d be happy to take a look.
John Osbon – email@example.com