3 Portfolio Checkup Traps to Avoid

Here are a few common traps to avoid as you perform a periodic portfolio review.

Trap 1 – Focusing on the Details, and not the Overall Plan

A common mistake is to too quickly get into the “weeds” of your portfolio, focusing on the performance of individual holdings within the portfolio, while missing the more important big picture of the overall plan.

Portfolio software tools, such as the x-ray tool on Morningstar.com, provide a lot of analytics for looking at your portfolio, enabling investors to assess their portfolio by numerous variables. These variables include items such as company’s size, investment style, sectors, geography, and much more.  But before investors get too focused on the analytics and performances of their portfolios, it’s better to take a step back and think about your overall financial and investment plan, specifically, is the plan on track?  That’s really the primary question you want to ask when you do perform a portfolio checkup.

The assessment and viability of your overall plan will often differ whether you are still in accumulation mode, or whether you are near or in retirement. For folks in accumulation mode, the assessment should include a review of whether you’re on pace to save enough for retirement and other personal goals. If you’re someone who is getting close to retirement, it’s reasonable to use what’s called the 4% guideline when looking at your portfolio. So, you’re looking at your current balance, you’re taking 4% of that balance, and determining whether that amount plus any amount that you expect to get from Social Security or a pension, whether those amounts together will provide you with a sustainable living stream of income in retirement.

The starting point for any portfolio review should be an overall review of the plan, and your progress in relation to that plan.

Trap 2 – Focusing too much on Short-Term Performance

Another mistake to avoid is focusing too much on short-term performance. If you’re reviewing your portfolio, you’re reviewing your positions, there will be a natural tendency to let the holdings that have performed well run or perhaps to even add to things that you didn’t have that have performed well.  Additionally, the overriding natural tendency would be to reduce or even eliminate your allocations to those assets classes which have performed the worst, and re-allocate those investments towards those asset classes which have most recently performed the best.  This is the exact opposite of what should be done.  Invariably, asset classes which have performed the best in the shorter term, become the asset classes which underperform in the future, and the investment of money often occurs after the upside movement has already occurred.

Having the discipline to an overall asset allocation is one of the most important, yet difficult, aspects of investment management. Setting, and adhering to, an overall asset allocation and a re-balancing strategy is a foundational component to successful investment management.

Maintain perspective and long-term discipline. Investing can provoke strong emotions.  In the face of market turmoil, some investors may find themselves making impulsive decisions or, conversely, becoming paralyzed, unable to implement an investment strategy or to rebalance a portfolio as needed.  Discipline and perspective are the qualities that can help investors remain committed to their long-term investment programs through periods of market uncertainty and volatility.

Trap 3 – Ignoring Tax Implications

A third mistake that investors often make is to assume that just because the market has mounted a comeback that there’s nothing in their portfolio that they could utilize from a tax-loss selling standpoint. One of the silver linings that investors sometimes have in weak market environments is the opportunity to prune holdings that have depreciated since their initial purchase.  The virtue of doing that is that you can take those losses, assuming that you hold this holding in a taxable account, and use them to offset capital gains, or to offset ordinary income up to $3,000 each year.

Even in years in which the overall market has performed well, there may be holdings within your diversified portfolio which provide you the opportunity to harvest losses and benefit from a tax perspective.