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Four key elements of a year-end portfolio review

by | Nov 27, 2014 | SELF-PUBLISHED

Why they’re important to your financial health

Your investment portfolio isn’t carved in stone. These days it’s most likely saved in a digital file somewhere. Every month, you should be receiving an itemized statement of what’s in that digital file as of the close of business on the last day of the month, how it’s performed, what it has cost you, how much it’s worth, and how much it’s changed since the last statement and since the beginning of the year. What it won’t tell you is whether it’s time to make changes. And that’s something only you and your advisor can do, preferably close to year-end. Here’s how.

Portfolios change with markets

Through the year, markets fluctuate, assets gain or lose value, investment positions grow or shrink as securities are bought and sold, and dividends and interest are collected and reinvested. All this is bound to have an impact on the characteristics of your portfolio. A strong equity market, such as we’ve experienced over the past year, is likely to be reflected in increased values of the stocks in your portfolio. Likewise, higher bond yields result in lower bond prices, which are reflected in lower values for your bond holdings.

When you add it all up, what you thought was perhaps a 50/50 fixed-income/equity split in your balanced portfolio at the start of the year has become a 40/60 split or even at 30/70 fixed-income/equity split at the end of the year. The net effect is that your overall portfolio risk has grown considerably, because your portfolio is now overweighted to stocks, which are considered riskier than fixed-income. If left unattended, this can have a serious impact on your portfolio performance the next time stock markets enter a bearish phase.

Review to rebalance

That’s why an annual portfolio review (and if necessary, a rebalancing) is essential. Here are the key components of a review to discuss with your advisor:

  1. Asset allocation

How you divide your assets among the three key asset groups (safety, income, and growth) largely determines the return you can expect and the risk that you’re accepting over your expected time horizon. When that allocation is skewed by extraordinary gains or losses in one class or another, your risk profile will change as a consequence. Review your asset class weightings annually to ensure your portfolio still meets your time, return, and risk profile.

  1. Diversification

Is your portfolio sufficiently diversified in each main asset class? Diversification is at the heart of best practices portfolio planning. It makes no sense at all from a risk-mitigation perspective to have your portfolio allocated 50% to fixed income and 50% to equities, and then have only one bond and one stock in each class. Review your portfolio annually to ensure individual asset classes contain sufficiently diversified individual securities. In fixed income, for example, you’d spread weightings among federal, provincial, and corporate bonds. And in equities, you’d diversify by sector, by region, by capitalization, and so on to achieve your desired risk level.

  1. Security selection

When researched, analyzed, and selected properly, individual stocks and bonds within a portfolio work in harmony to achieve a specific purpose, say a minimum dividend yield or a specific target price gain or a specified yield to maturity. When that target has been achieved, the position is usually analyzed to determine whether a switch or change within the portfolio is needed. Sometimes this is done at year-end in conjunction with generating tax losses to cover capital gains.

  1. Mutual fund/ETF review

If, like many investors, you’ve outsourced your portfolio to mutual funds (for active management) or exchange-traded funds (to take advantage of low-cost passive diversification), you should review your investment rationale and compare it with the funds’ performance over the past year. Are there reasons to switch or rebalance funds, for example, a change in manager or a change in focus or mandate (in the case of mutual funds), or a change in index methodology or liquidity or ownership (in the case of ETFs)? Funds and ETFs are frequently closed, merged, and renamed. If this has occurred to your funds, review the new funds’ mandates to ensure they’ll still deliver what you expected when you first purchased them. If not, consider switching.

A second look can help

Conduct your annual review with your independent advisor, who should be able to provide insight on whether prospective rebalancing will have unintended tax consequences or other unwanted effects on your portfolio. And remember, your objective is not to remake your portfolio, but to restore it to a state where it continues to meet your time horizon, risk tolerance, and return objectives.

© 2014 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited.

© 2023 by Robyn K. Thompson. All rights reserved. Reproduction without permission is prohibited. This article is for information only and is not intended as personal investment or financial advice.

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