One of the first things a homeowner learns is the importance of inspecting conditions regularly and performing maintenance as needed. All it takes is one leaky sink that, over time, ends up putting a damp hole in your drywall to remind you that making small adjustments regularly can save you from having to handle bigger issues down the road.
It’s the same with your investment portfolio. The third and final (though never finished) step in portfolio construction process outlined in my blog series is conducting a regular review. This step helps you confirm your investment strategy still fits your goals and situation—and to make a few repairs if needed.
Remember Jim and Sue Smith
Here’s a quick refresher on Jim and Sue:
- Married, both in in their 50s.
- Both to receive Social Security; Jim also has a pension from an employer.
- Investment accounts with several firms, including employer retirement plans, individual IRAs, Roth IRAs, and nonretirement accounts.
- Unsure of their overall asset allocation or of all the different investments they hold.
Schedule regular portfolio maintenance checks
When your balances are all going up, it’s easy to stay with the plan. It’s when we run into a downturn that it can be hard to stay with your allocation.
You want to make changes to your portfolio for the right reasons, not because of emotion. One way I’d help Jim and Sue (and do help all my clients) is by reviewing their allocations quarterly.
There may be times when one asset class in your portfolio performs really well—or when one doesn’t. Regular reviews help ensure that any variations from your long-term allocation and investment strategy get identified early so you can decide what, if any, adjustments make sense.
Take care of repairs—and don’t fix what ain’t broke
I tell my clients, “There’s always some darn thing going on.” The key is to tune it all out and stay focused on your long-term goals and the agreed-upon asset allocation. It’s the allocation that’s our driver, not the underlying investments or a perceived risk or gain.
If we find that the portfolio is more than 5% away from the client’s original allocation, we’ll rebalance regardless of the “news” that’s spinning around. It’s like when your back deck slants because one part of your yard lost some dirt through erosion while the other side is raised up from a build-up. You want to maintain a nice level surface.
Returning to the Smiths, let’s say the market has been kind and, on their quarterly review, we find that their stock percentage has grown and is more than 5% higher than the allocation we set. Is is at 76% instead of 70%? We would take the profit off the table, sell the 6% increase, and rebalance into the bond portion of the portfolio.
Conversely, what if the market went down and the stock percentage was 64%, not 70%? This situation can sometimes be a little more challenging emotionally, especially if it “looks” like things are not going to improve (Take 2008–2009 for example). Again, I’d strongly suggest turning off the news and then buy low—sell the bonds and buy back your stocks to return to the 70/30 allocation. Doing so should put you in a better position when the market recovers.
Use the right account tools for tax efficiency
No one wants to pay more taxes than necessary. Rebalancing can result in tax consequences, but there are some tools we can use to contain those costs.
The first is using money you don’t already have invested—perhaps from a gift or savings you’ve earmarked to shift into your portfolio—to buy investments in the asset class you need to realign your allocation. You can use investment income earnings or capital gains distributions that end up deposited in your money market or other cash account. This way you don’t have to sell a sector that’s doing well to balance out a sector that’s doing even better.
Another tool to wield if we need to pull back on a particular asset class’s holdings is which type of account we sell investments from. Let’s say the Smiths need to adjust the stock portion of their portfolio and they have holdings in both tax-deferred IRA/401(k) accounts and a taxable brokerage account. We’d sell holdings from the tax-deferred accounts first to help offset capital gains taxes.
Confirm quality construction
As with your home, the quality of the construction process can make the difference between a structure that will last you over the long term and one that won’t. The three steps I’ve laid out in this series—going through the portfolio-construction process of laying out your blueprint plan, assembling the structure, and performing regular maintenance—provide a sensible plan for success over the long term, regardless of market conditions.