You’ve gone through the drill: sat through intense discussions with your adviser on how much you should save and invest; read through reams of information about the various investment options out there (stocks, mutual funds, ETFs, etc.); and probably battled the urge to invest in some super exotic product that promised you a yacht in less than 10 years. Finally, you have a portfolio of investments that puts you on course to achieve your most important financial goals.
At this point, you’ll find yourself falling in one of two broad categories of investors. You either can’t wait for the next day’s papers to start tracking how much your investments have gained, or you hope you never have to see another market or research report again! The excitement and the fatigue are both understandable – but the secret to creating wealth from your investments over the long term lies somewhere in between. You’re investing to meet certain specific goals, and tracking the markets on a day to day basis will only make you confused. However, completely forgetting about the portfolio is no solution either; regular, once-a-year reviews are what will help ensure that your portfolio stays on course to help you meet your goals.
Having decided to do a portfolio review, it is critical to do it right. Hasty or biased assessments, using incorrect parameters, can mean unnecessary churning of sound investments. If you’ve invested after consulting a financial planner or a fee-based SEBI registered investment adviser (RIA), portfolio reviews will likely be included as part of their annual service. If not, you might need a portfolio or investment management expert for an independent, unbiased review of how healthy your portfolio is. Let’s understand why.
Fluctuating Vitals: The 3-Step Health Check
Left to themselves, portfolios can change significantly over time in terms of performance, risk exposure, concentration or diversification, and cost structure. And it is never easy to understand which of these changes are warning signs to sell off an investment or bring in a new one. For example, if a particular investment has been giving low or negative returns for the last 6 months, should you sell it off and book your losses? Decisions like these are never straightforward: market changes affect each portfolio, and each goal, differently, and working on generic advice does more harm than good.
An objective, and correct, portfolio review thus involves looking at individual investments with a thorough bottom-up approach, starting with the fundamentals of the investment, your goal, your risk profile, your tax status, as well as the larger market conditions. As a process, it would involve the following three steps:
A well-diversified portfolio would, at any point in time, have a fair balance of investments that are doing exceedingly well, some that are steady and some that are sluggish. The investments should not be too positively correlated. That’s part of the design, and not something to worry about in itself. Very few value investments deliver returns in a straight upward graph, and the basic tenets of long-term investing state that cyclical changes should be waited out, without giving in to fear or greed. Good or bad performance don’t necessarily prescribe buying or selling the investments. The valuations of the underlying assets are a better indicator. When a market becomes euphoric and valuation goes over the roof, it makes more sense to sell it when it is doing well and then buy into an under-valued asset that is not doing well as long as the fundamentals are still strong.
However, bad performance due to a change in the fundamentals of an investment can be triggers for a sell: for example, a policy or global market change that affects the prospects of a certain industry, sector or company; a corporate governance issue that impacts the value of a stock or bond; or even changes in regulation that affect the liquidity, tax benefits or composition of a product. In these cases, the adviser will look at the other options in the market that offer similar return-for-risk balance in line with your goals and risk profile, and recommend that you make a change. Tax implications are also an important consideration in this situation, and your adviser may ask you to time the sell transaction to allow proper write-off of capital losses if any, thus reducing your tax burden.
Asset Allocation Check
The asset allocation of your portfolio (the distribution of your investments between equity, debt, cash, and other asset classes) forms the basic framework for the selection of your investments. Getting the asset allocation strategy right, and sticking to it in a disciplined manner throughout the tenure of the portfolio, can give you the strongest possible chances of actually achieving your financial goals.
Over time, different asset classes compound and gain value at different rates, and the weight of each asset class in your portfolio may change. As a result, that the risk exposure of your portfolio may change without you really being aware of it. This is where portfolio rebalancing comes in, which is a disciplined re-setting of your portfolio to its intended asset allocation. For example, if at the end of a particularly racy year for the capital markets, your equity investments have grown at a much higher rate than your debt investments, making the equity allocation of your portfolio rise from 70% to 85%. In such a case, your adviser will assess all your equity investments and recommend selling off a few to bring equity back to 70% weight.
Life and Goals Check
When starting off a portfolio review, an adviser will always ask you about any change in your life that should reflect in your investments. For example, increase in earnings; inheritance; loss of a job for either spouse; or even the approaching end of a goal. These are all triggers for the risk profile and asset allocation of your portfolio to be changed.
As a rule, the longer you have to achieve a goal, the more the risk the portfolio can afford to bear. As a goal approaches fruition, it is advisable to move your asset allocation to the conservative risk spectrum and focus more on wealth preservation than wealth generation. These alterations should also be made if there are other changes in your life. For example, if there is an increase in earning and saving capacity, and your goals stay the same, you can ask your adviser to reduce the risk of your portfolio and move to a more conservative asset allocation.
Each investment and every portfolio, however solid, needs to be reviewed periodically to ensure that the balance of returns and risk is in tune with your goals and risk profile. Doing this with an objective, unbiased point of view is important to ensure that you are not doubling your opportunity costs by selling and buying due to the wrong reasons.
Source: Previously published on Rediff.com in August, 2019