Adding more controls to your investment process

September 6, 2021 by admin

It’s easy to overcomplicate your investments, and hard to fix that problem.

Investment portfolios age, grow and change with their owners. Many people gather investments and amass a collection without managing positions, selling and trimming to concentrate on strategy.

It might be easy to solve that problem if there were rules for everyone to follow, but there are no actual guidelines for keeping a portfolio simple. Everyone’s standard would be personal, every situation would have it unique loopholes or special exceptions and – as with most things investing – there is no one “right way.”

Last week, this column focused developing personalized protocols to govern your portfolio.

Having ground rules and adjusting your portfolio to these instructions/limitations will go a long way to keeping a portfolio on track and effective. Your portfolio precepts will change over time and should be reviewed and adjusted every few years as part of regular maintenance.

The concepts covered last week were minimum position size, maximum positions to hold and the number of accounts you have. Those notions are more about how you construct a portfolio than the investments themselves; today, we look at taking better control of your holdings.

Here are three ways individual investors can develop guidelines to better manage their holdings.

— Your long-term performance threshold.

No one sets out to buy a clunker; you add stocks, bonds or funds to your portfolio expecting superior results.

Sometimes, the early returns are particularly good; you buy a recent standout and the hot performance continues. That can make you comfortable sticking around even if performance regresses.

Too often, investors stick with fallen angels, investments that “were good to me once.”

I’m not immune. I recently looked at a long-time Roth IRA holding where the fund’s 15-year track record is great, but 10-year returns are well below average. I shouldn’t have been surprised – the fund lagged its peer group in seven of the last 10 years – yet I was.

I was so focused on the longest-term results that I let recent underperformance slide. Yet with all of the recent trends being negative, my review made it obvious that the fund’s best days are behind it.

With no reason to expect a reversal in that performance trend, I made a change.

Too often, investors are so satisfied to see progress that they fail to see that their holding is, relatively speaking, a laggard.

Come up with guidelines for your expectations. Look at both absolute and relative performance to determine your satisfaction.

In my case, I want superior long-term results and above-average intermediate (3-5 year) returns from my funds and ETFs. I seldom worry about short-term and recent results, other than to note that a bad year might put something on the watch list to make sure that sluggishness isn’t turning into a trend.

In stocks, I’m looking to see if the investment meets my growth/dividend expectations, and performs admirably relative to its peer group.

It’s possible to be making money in a disappointing investment; developing absolute and relative standards you want to see over time will help you manage a portfolio and clear out the dead wood.

— Your reasoning “then versus now.”

You don’t buy investments willy-nilly. There’s a reason and a purpose for everything you own.

Yet over time, most investors forget their motivations.

Maybe you bought a mutual fund or ETF to diversify your portfolio, because it had a good rating from a research firm like Morningstar, for its superior long-term results, for the above-average income it was generating and/or because you were impressed by the manager in an interview or article.

Years later, the ratings could have changed, relative results might be less impressive, the manager may have moved on and so forth.

Investors should write down their thinking every time they add a security to the portfolio, so that they can revisit that thinking later.

But whether you recall your reasoning or not, a simple standard is this: If you wouldn’t buy it again today, it probably doesn’t belong in your portfolio.

— Tax considerations.

Taxes are a complicating factor that can muck up a simplification plan.

You don’t want to deconstruct a portfolio or sell off your mistakes in ways that sock you with a tax bill.

Sometimes it is worth hanging on rather than take the tax hit.

That’s a case-by-case situation; avoiding taxes at all costs can leave a portfolio an outdated mess. Don’t let the fear of a tax bill paralyze you, whether that’s paying to convert a traditional IRA to a Roth or selling a security in a taxable account.

The last time I raised/re-established my minimum position size, for example, it forced a decision on a stock I bought for a few hundred bucks during the 1980s. It had grown 12-fold in three decades — so most of any sale would face capital gains taxes — but the company was a retailer struggling to keep up in an online world.

I wouldn’t buy more, but didn’t want to pay about $1,000 in taxes for dumping it.

Ultimately, however, investment decisions outweighed taxes.

Yes, there may be steps to minimize tax consequences of a portfolio clean-up, through tax-loss selling (though the market at record highs can make that tough), gifting appreciated shares (instead of cash) on charitable contributions, and more.

But many people never sell, letting death sort out the taxes when the security is passed to heirs with a stepped-up basis (valued on the date of death rather than the long-ago time of purchase).

Determine when it’s better to bite the bullet and give Uncle Sam his due.

Don’t let the penalty of paying taxes now rob you of the long-term rewards of better investing. Don’t just weigh the tax hit, consider the opportunity cost.

I sold the retailer, paid the taxes and reinvested the proceeds, which have blossomed; despite the tax hit, I’ve come out ahead.

Avoiding taxes is good, but having a profitable, comfortable portfolio you believe in is better. Find the balance.

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Chuck Jaffe is a nationally syndicated financial columnist and the host of “Money Life with Chuck Jaffe.” You can reach him at itschuckjaffe@gmail.com and tune in at moneylifeshow.com.