As with most things in life, it’s what’s on the inside that really matters. But until you perform an in-depth check-up you can’t know whether or not that healthy looking portfolio is truly thriving, or if it’s suffering from any of these common investment maladies:
1. Diversificationitis: A portfolio that lacks investment diversity and is therefore unable to withstand various market climates.
2. Over/Underexposure: A misaligned risk profile with symptoms that become most pronounced during periods of market volatility.
3. Fee infestation: The corrosive effect of investing fees can be chronic. If left untreated it leads to serious long-term damage.
4. Stunted growth: A condition that can go unnoticed unless an investment’s returns is compared to its peers.
5. Tax tremors: Symptoms are often triggered during periods of buying and selling when gains and losses are reported to the IRS.
Left unchecked these, these conditions can prove fatal to your investment returns.
Stress Test Your Portfolio
When’s the last time you gave your investments a good once-over? We’re not just talking about your IRA or your 401(k), but all of it at once -- all of those investments bought at different times, subject to different tax treatments and fees, and invested with whatever goals you were pursuing at the time.
The key to steady long-term returns is to be diversified, meaning allocating your assets among enough different types of investments so that they don’t all move in lockstep. A portfolio’s true diversification is measured by how its investments differ in terms of exposure to asset class, industry, size, investing style and geographic location. When any single investment in your portfolio rises or falls, your investment mix can be thrown out of whack. That’s why FutureAdvisor recommends checking your allocation at least quarterly, and rebalancing your portfolio whenever a particular asset class starts gaining too much weight for an extended period of time.
Risk tolerance plays an important role in determining an investor’s ability to stick with a strategy during periods of market volatility. The factors that determine your risk tolerance are your investing time horizon (e.g. when will you need the money) and how much market turmoil (those inevitable peaks and valleys) you can stomach. It’s true that the more risk you’re willing to take the higher your potential returns. But it’s all about striking a balance. Get the risk-reward balance wrong and the whole investing strategy falls apart when an investor panics and dumps assets at the first sign of trouble. Measuring your own and your portfolio’s risk profile helps you avoid holding assets that don’t sit well with your temperament.
If you have to focus on a single financial health metric, fees would be the one. When it comes to investing, the more you pay, the less you get. Literally. Remember, every single dollar you pay in fees is a dollar that doesn’t have the chance to remain in your account and compound and grow over time. Studies have shown that the key to market outperformance is keeping fees (fund fees, management fees, trading fees, retirement plan fees) in check. [Morningstar: http://bit.ly/1js28hQ]
A mutual fund’s performance may look good at a glance, but the only way to measure its true performance is to compare it to the returns of its peers and/or an appropriate benchmark index. If you discover that an investment is consistently under-performing, grab a scalpel and check for -- you guessed it -- a fee infestation.
Related to fees and just as important to improving your overall returns is the effect taxes have on your investments -- both near-term and in the future when you start to withdraw money to live it up in retirement. Smart tax strategy involves putting the right kinds of investments in the right type of account (e.g. taxable; tax-exempt); selling underperforming investments at the right time to offset gains elsewhere (tax-loss harvesting) and other tax-smart moves that help you sidestep an avoidable tax bill.
The Portfolio Doctor Is In
Don’t wait until it’s too late to check and see if your portfolio is exposed to wealth-destroying maladies. We’ll run a detailed screen of your existing holdings and evaluate everything you currently own based on the five factors we outlined above. We’ll then design a well-balanced, low-cost, risk-appropriate portfolio to get you on the best path to your goals -- at absolutely no cost to you.
See how healthy your portfolio looks on the inside with a free checkup on your IRAs, 401(k)s, bank accounts, brokerages and college savings accounts.