Portfolio Maintenance 101: Seven Critical Questions

By Tom Madell

Many people have contacted me for help in arriving at and maintaining an appropriate fund portfolio during the last several months. Each investor, of course, has a different set of circumstances which means that merely recommending the identical "cookie cutter" portfolio for everyone doesn't make sense. Compounding the difficulty is that we are now operating under a situation, namely the coronavirus, that has never been experienced before, and for which there are still far too many questions than answers.

Without a doubt, putting together and, if necessary, altering a suitable portfolio on your own is difficult. While some might turn to an advisor to do the work for you, for those who don't, if you are able to answer some critical questions about your personal situation as well as attitudes and beliefs toward investing, you should be able to proceed to make decisions as well as an advisor can. Of course, picking which particular funds you should include is a totally separate issue that I will not address in this article. Most investors can find at least several separate resources to help them do that.

So let me enumerate some of the issues which may influence an investor's decisions as to how to themselves pick the types of funds they should or maybe shouldn't own and in what proportions within their portfolio. All of these issues have always been pivotal but some may have been brought to the forefront during the now prolonged pandemic. But remember that, as time goes by, one's personal situation and attitudes may change, leading you to think about these issues differently, thus resulting in your modifying your decisions about your portfolio.

1. Which is more important: Staying the course or staying flexible? The phrase "staying the course" as applied to investing seems to suggest that once you've decided upon what appears to be a reasonable plan for your investments, you should stick with it regardless of market conditions. It seems to be largely akin to the philosophy of buy and hold. In both cases, adherents argue you should not change course in spite of market turmoil or the current investment fads of the day. How closely you believe in and adhere to either of these phrases will determine your attitude toward making changes in your portfolio.

Realistically though, the best laid plans for staying the course often go awry when either the entire market or a particular investment or investments drop severely or show extreme turbulence. Do you drop out or ride out the turbulence? While many investors think of themselves as buy and hold, we know that it is extremely hard to do as waves of redemptions usually occur in times of extreme market angst. While bear markets may not arise that often, the fear so induced may cause some investors to abandon their best laid plans, putting their portfolio out of whack. Even when the selling appears to stop, such investors are now faced with the question as whether and when to re-enter the fray. But if you are truly a buy and hold investor, you should probably not be frequently questioning the appropriateness of your portfolio. For such individuals, there may be little or no portfolio maintenance to do except when your personal situation changes.

Of course, the other side of buy and hold is that of frequent repositioning. In reality, changing course midstream, while undertaken to help your bottom line, may wind up hindering it as well. Is there unanimity in the investment world regarding which is the best course of action? Like so many other investment issues, there are no clear answers to guide the average investor, making portfolio maintenance all the more difficult.

2. What importance do you place on past performance? This issue comes up when first selecting a fund, but also when deciding whether to continue to hold it, buy more, or sell a portion (or all) of it. In spite of admonitions that past performance should not be the only key to fund selection and maintaining its continuing attraction, no one can deny that it should play at least somewhat of a role in your decision making. But just how important should it be, and if and when might it trigger a reconsideration of your choices?

You must decide whether your portfolio stalwarts will be mostly funds with excellent ongoing performance, or, will you swing toward one or more funds that have all the characteristics of good funds, but have underperformed other possible choices for a considerable period of time.

What I have observed is that most investors still tend to assume that excellent past performance is the main reason why they want to hold a fund. But we should also be aware that great past performance is no guarantee of great future performance. Yet almost all of us, and I must admit myself, tend to grab on to the most easy to way to choose among alternatives, which is how the fund has done previously. For this reason, it should be no surprise that those funds that attract the most investor assets are those that tend to have performed best over the last 5 to 10 years.

But can an opposing case be made that may be equally as valid? This is that one should consider the inclusion of out-of-favor funds or fund categories that have underperformed. Such funds will perhaps hold more future potential than funds that may have become "too hot" or "overvalued," It seems that one must come down on one side of the issue or the other. And that appears to greatly depend on your "theory" as to how investments operate. Specifically, is there no limit on how high an investment can grow, or, do investment gains tend to average out over the years? In short, should one's focus be yesterday's and today's winners or on uncovering tomorrow's?

Mediating relying too much on past performance, some investors want a portfolio that tries to include most or all the major asset classes, regardless of past performance. If so, they may focus mainly on diversified choices rather than always selecting in terms of good or poor performance lately.

3. How old are you? The more potential years of investing you have ahead, the easier it might be to make important fund investment decisions. Yet as you get older, such considerations may well change.

It makes sense that younger investors can afford to take on more risk because, if things start to go badly, there will be plenty of time for their portfolio to recover. This is not necessarily the case for older individuals. Besides, relatively younger investors presumably still have the prospect of falling back on their job or career to tide them over if their investments are faltering. On the other hand, someone in retirement may need to rely totally, or nearly so, on their investments to be able to continue their current lifestyle or even the basic essentials they require; such would often suggest a more conservative approach.

This might mean that if you are below 65 and/or still working, you might want to have a higher allocation to stocks than a person who is 65 or over and possibly retired. And the funds/ETFs/stocks you choose to own as a relatively younger person might be more aggressive and volatile, ones that can do extremely well, but also quite badly if conditions turn very adverse.

As you age, many investors might turn to bonds to a greater degree since most bond funds do not expose you to nearly the degree of risks that stocks do. But bonds, too, can also vary greatly in terms of risk characteristics. Just as for stocks, while a younger person can opt for relatively risky categories of bond funds in order to strive for higher rewards, a relatively older person perhaps might choose to stick with less risky ones rather than those that could inflict big negative returns under certain circumstances.

4. What has been your past experience as an investor? There is a saying that "success breeds success." So, simply put, if you have done well or even perhaps observed others do well in their investing, it is more likely that you will be more plucky in your current investing than otherwise. Of course, the reverse is true as well.

More specifically on the negative side, did you you lose money from which you never recovered during the 2000 to 2003 or 2007 to 2009 bear markets? (The same type of extended bear market may have appeared to have begun between Feb. and March of this year, and could still happen, although it seems increasingly unlikely; nevertheless some investors feared the worst, and opted to sell at a loss.)

The past history of such losses induces some investors to be fearful of the same thing happening again, if not now, at some time in the future. As a result, you may think it wise to to keep your investments, if you retain them at all, in the least risky investments you can find. You may even permanently move all, or a significant portion, of your assets into money market funds or CDs regardless of how puny the yields may be. And even when these instruments return to paying what seems like a more reasonable amount, let's say 3% or more, you might continue to choose such investments as being a better match for your needs and/or temperament than either stocks or bonds.

5. Are you seeking additional income? Some investors rely on their investments to have enough regularly recurring money coming in to meet their expected financial needs. If so, this may necessitate gravitating toward funds that pay a higher level of dividends, usually, but not always, bond funds. On the other hand, investors who have no need for such regular income can pick funds regardless of dividend payouts. For example, many technology-oriented stock funds pay little or no dividends at all but offer the prospect of higher "total returns," meaning most of their attraction is a result of the potential appreciation in the value of their portfolio holdings.

In other words, if you need income, you may steer your portfolio in that direction while potentially avoiding investing in low dividend-paying funds which otherwise might have even bigger total returns than higher dividend funds, but likely spreading out whatever gains there may be unevenly over time depending on the performance of the investment,

6. Will you be financially prepared if stocks plummet? If not, you may feel impelled to sell, perhaps incurring significant damage to your nest egg. You will have to decide whether to cut your losses or try to ride it out.

If you have accumulated enough total assets to carry you through regardless, you may be spared from being forced to sell; even a stock market crash might not cause you irreparable harm. Or, if you have a large emergency fund, you should be able to ride through market crises without worrying about seriously diminishing your future retirement plans or surviving financially when markets drop. Since long-term portfolios have virtually always come back after extended drops such as referenced above and gone on to greater gains, you can afford to continue to ride out the storm vs. someone who feels impelled to keep themselves afloat only by getting out of stocks. Perhaps that's partly why as the saying goes "the rich get richer." Why? Because they continue to hold their investments through thick and thin.

Alternatively, if you have a well-diversified portfolio that includes a significant position in relatively much less volatile short-term bonds, being able selling them to raise cash for necessary expenses rather than stocks might also be a consideration as you prepare for an always unknown future.

7. Are your investments in taxable accounts or tax-deferred ones, or both? If some of your investments in a taxable account, you will need to consider the tax consequences of any purchase or sale. This may inhibit your potential decisions one way or another.

Most bond funds, except municipal bonds, and even stock funds, will spin off taxable income which diminishes your actual reported returns at tax time. So you may be reluctant to invest in such funds in such an account regardless of their ability to serve as a ballast to your stock funds. Likewise, you may be weary of incurring large capital gain distributions by year's end if you want to invest in a managed fund as opposed to an unmanaged index fund or ETF.

And if you decide it's wise to sell or exchange out of one of your highly profitable funds and preserve that profit or for strategic reasons, you have to weigh the fact that you will most likely incur a capital gain on that investment in your taxable account.

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Here are two topics that may be of interest to investors raised by readers' questions.

High cost newsletter

Investor: Should I purchase a particular Higher Risk/Speculative Stocks newsletter I came across whose model portfolio has done tremendously well over the past 10 years? I am a younger person who can invest with relatively higher risk with many years/decades until retirement.

My Comments: This is just my opinion, so you can take it for what it's worth: It is extremely difficult for anyone to beat an index such as the S&P 500 Index. So a newsletter might be able to beat it over certain periods of time, but not consistently.

The example newsletter you mentioned shows that portfolio of higher risk stocks did amazingly well over 10 years, but when you look at the 5 and 15 year returns, it trailed the S&P 500. So, success with a newsletter might depend on how long you were able to stick with the portfolio and how it did over those particular years.

I know nothing about this particular newsletter so I can't give you an opinion whether it's worth the $300/yr. But my feeling is that by merely investing in an S&P 500 index fund, or a total market index fund, you have as good a chance or better of doing better than most newsletters without the subscription cost.

A high allocation to stocks

Investor: I am 69 years old and consider myself a moderate risk investor. About 80% of my portfolio is in stocks/stock funds, 17% is in bonds, and 3% in cash.

My Comments: This is quite aggressive for someone your age. I recommend that it should be closer to the 65/35 with perhaps some of the non-stock portion just in money market funds in case you need to cash some money out in an emergency. This means you may need to select some of your stocks/stock funds to sell and to put the proceeds into bond funds. Once you pass away, you don't want your wife to have an aggressive portfolio if she is not an investor.

I also suggest you trim down your number of holdings - I count that you have 17. Many of the stock holdings probably have a high correlation with each other. This means that they are not really very different from each other, going up or down at the same time and thus not as diversified as you might think.

In considering whether one might have too many funds, you might choose to eliminate a fund that hardly varies from another that you also own. What is a high correlation for funds? Unfortunately, we find that most stock funds are highly correlated, 0.90 or more, 1.00 being the highest possible. A correlation in the .80s would suggest that there are some differences so that would be the minimum I would look for. A correlation less than .80 means there are significant differences between them. You can see the correlation between 2 funds at https://www.portfoliovisualizer.com/asset-correlations.

For example, if your own both Fidelity Contra fund and Vanguard Growth Index, you will find that their correlation is 0.99 over the last 10 years! If, however, you own both Vanguard Short Term Corporate and Vanguard High Yield, even though they are both bond funds, their correlation is only .42 which means you are getting something quite different with each.

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If interested in getting a free portfolio review of your current investments (or if you started the process but did not get to complete it), my offer is still available. See the Aug. Newsletter for details. Many investors have already taken advantage of this offer and most appear satisfied.

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