When it come to investing, are you a micromanager? Or a hands-off type? Micromanagers obsess over their portfolios. They switch in and out of investments with every tic and tremor on Wall Street or in the economy. Hands-off types are the opposite. While they might polish and buff their cars every weekend, they pay little attention to whether their portfolios are on track to achieve their investment goals.
Whatever kind of investor you are, you stand a better chance of reaching your investment goals if you take time to analyze your entire portfolio at least once a year. By identifying weaknesses and making adjustments, you can help ensure that your portfolio is performing efficiently.
Perform Asset Allocation Modeling
According to an often-cited and time-tested study* held in high regard by many professional investment managers, more than 90% of investment success is due to asset allocation rather than stock selection or any other strategy. This means that investors who carefully allocate their assets among a variety of asset classes (cash, bonds, and stocks) have a greater potential of increasing their returns and lowering their overall investment and market risk than those who invest in only one asset class.
Why? Because asset classes respond differently to the constantly changing economy. Dividing your assets among the different classes makes your portfolio less susceptible to loss if one investment class performs poorly. Your financial planner can help you develop an appropriate asset allocation based on your investment objectives, age, risk tolerance, and time frame.
Do a Stress Test
Will your portfolio accomplish your objectives? Take retirement, for example. Will you be able to afford the retirement lifestyle you want? Will your retirement portfolio be able to cover your future living expenses? Financial planners use software that employs 'Monte Carlo' simulation to provide answers to these and similar questions.
Using key variables - such as income, assets, expenses, time frame, projected returns, tax rates, inflation, interest rates, etc. Monte Carlo simulation produces thousands of possible future scenarios. While it can't predict the future, it can forecast the probability of success under a wide variety of conditions.
Analyze Your Portfolio's Tax Efficiency
Reducing the tax bite on your investments is one of the keys to building wealth. So, you want to be sure that your portfolio is as tax efficient as possible. For example, if you are saving for retirement, it makes sense to invest through your employer's retirement plan or some other tax-deferred vehicle such as an individual retirement account (IRA). All things being equal, tax-deferred accounts grow larger over time than taxable accounts.
For taxable accounts, a buy and hold strategy may increase tax efficiency. By limiting investment trades, you can limit capital gains taxes, thereby increasing your portfolio's ability to compound earnings without reduction for current taxes. If you own mutual funds, you should be aware of how often fund investments are traded. The more trades a fund makes, the less tax efficient it may be.
We use "benchmarks" to measure everything from intelligence to baseball batting averages. Investment indexes serve the same function in the investment world. If you want to measure how well an investment is performing, compare its return with those of a comparable index. By comparing your investments to appropriate indexes, you have a way of determining how well " or how poorly " those investments are performing. Please note an index is unmanaged and on cannot invest directly in an index.
Perform a Cost Analysis
The less money you spend buying and selling investments, the more you have to invest for your future. So, it's important that you track how much you pay for trades and spend on sales charges and expenses. Compare your costs with those of similar investments. And, before you make a new investment, do your research. Read the investment prospectus and annual report.
High taxes, excessive expenses, unsuitable investments, or inadequate diversification can weaken the performance of a portfolio and slow its growth. If you want to be sure that your investments are performing efficiently, sit down with your financial planner for a thorough analysis of your entire portfolio.
* Brinson, Singer & Beebower Financial Analysts Journal, May-June 1991
Associates of First Financial Group of the South, Inc. offer securities and investment advisory services through Lincoln Financial Advisors Corp., a broker-dealer and registered investment advisor. Insurance offered through Lincoln affiliates and other fine companies. It is not our position to offer legal or tax advice. This information should not be construed as legal or tax advice. You may want to consult a tax advisor regarding this information as it relates to your personal circumstances.