Portfolio Makeover

Adam M. Grossman

AT LEAST ONCE a week, I run across the sort of portfolio I like to call a “broker’s special.” While each is different, they typically include some mix of the following:

  • A handful of mutual funds with names like “New Economy” or “New Discovery” or “New Perspectives.”
  • Some commodity funds.
  • 10 or 20 individual stocks.
  • Funds with names heavy on buzzwords such as “infrastructure” and “renewable energy.”
  • And, in some cases, master limited partnerships, options or other derivatives.

In all, there might be 25, 50 and perhaps more separate holdings. What’s wrong with a portfolio like this? In addition to the obvious drawbacks—unpredictable performance, unnecessary cost and tax-inefficiency—perhaps the biggest issue is that these portfolios are so complicated that it’s virtually impossible for investors to know what they own.

To be sure, account statements will list each holding, but that’s of little help when the list is as long as your arm. Meanwhile, what gets obscured is the most crucial fact: the portfolio’s overall asset allocation—its breakdown between stocks, bonds, cash, commodities and other asset classes.

This is a critical shortcoming because, according to the research, asset allocation is the single biggest driver of a portfolio’s risk level and expected return. If you don’t know your asset allocation, you have no idea whether your finances are walking a high wire or resting on solid ground.

If you feel like your portfolio could benefit from some spring cleaning, I recommend these four steps:

Step 1: Productivity guru Stephen Covey used to talk about “beginning with the end in mind.” Using that approach, the first step in transforming your portfolio is to develop an ideal image of what you want it to look like. By this, I mean you should determine the asset allocation that makes sense for each account or group of accounts. For example, you might have one allocation for your retirement accounts, another for your taxable accounts and one for each of your children’s college accounts.

Step 2: Now that you have your ideal mapped out, you’ll want to compare each account’s current state to its ideal. To accomplish this, I recommend a tool like Morningstar’s Portfolio X-Ray, which is free, though you have to register with the site.

Step 3: If the most important factor driving your portfolio’s performance and risk is its asset allocation, it matters much less whether you pick Google’s stock over Apple’s. Instead, if the goal is to capture the returns of different asset classes, far more important is owning a basket of stocks, a basket of government bonds and so on.

That said, you still want to vet each individual holding to be sure you aren’t holding any ticking timebombs. I recall one portfolio held by an elderly couple. On the surface, it looked appropriate, with the bulk of their holdings in bonds. Upon closer examination, I saw that it was far riskier than it appeared, with bonds from corporate and government issuers that had spent time in bankruptcy.

Step 4: A well-worn rule of thumb dictates that investors should—to the greatest extent possible—hold bonds in retirement accounts and stocks in taxable accounts. The idea is to optimize tax efficiency, since bond interest and stock dividends are, for most people, taxed at different rates.

But times have changed. With bond yields so low, I think you can set aside this rule of thumb for now. Instead, I’d let your age and life stage drive this decision. Younger adults might want to have more bonds in their taxable accounts, where they would be accessible to meet unexpected expenses. Older folks, on the other hand, might want to have more bonds in their retirement accounts, to help meet required minimum distributions.

When should you start making changes? If you’ve evaluated your portfolio and decided it would benefit from some tweaks, I’d go ahead and do it. There may be a temptation to wait, based on your—or others’—opinion of where the market is headed. But in my view, this rarely works out.

Consider the market-timing advice offered recently by Goldman Sachs’s retired chief executive, Lloyd Blankfein. “There’s an old adage,” he wrote. “Don’t fight the Fed. Means that if the Fed is on a tightening course [i.e. raising rates], don’t be long [buying stocks]. And if the Fed is lowering rates, as now, don’t be short [selling stocks].” He issued this advice in September 2019.

At the time, the Fed had been lowering rates and stocks were indeed doing well, seemingly confirming Blankfein’s advice—except for one detail. About a year prior, in late 2018, the Fed had been doing the opposite: It had been in the midst of a multi-year course of raising rates and stocks were struggling. But then the Fed abruptly reversed course in 2019.

That’s the problem with “old adages” like this. If you’d been following Blankfein’s logic in 2018, you would have been scared out of the stock market. By the time you responded to the subsequent change in the Fed’s policy and bought back into stocks, you would have missed much of 2019’s 30% gain. The lesson: If your portfolio feels like a broker’s special, the best time to start making changes is now. Don’t delay—and certainly don’t base your decision on old adages.

Adam M. Grossman’s previous articles include The Wager RevisitedSeven Paradoxes and Cut the Bonds. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.

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Rick Connor
Rick Connor
1 year ago

Excellent advice Adam. I think most people don’t realize how much effort it is to track a complicated, individual stock heavy portfolio, especially as we age. Inertia makes it hard to do the kind of makeover you suggest, but it is worth it in the long run.

R Quinn
R Quinn
1 year ago

This reminds me of the 401k plans which offer dozens of investment options and making it virtually impossible for workers to build a reasonable portfolio but rather simply pick a score or more funds and thing they are diversified.

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