This is an extract from a conversation between Christine Benz, Morningstar’s director of personal finance, and Ashley Redmond from the editorial team in Morningstar Canada.
- Why is a portfolio checkup a good idea?
I would liken it to a wellness check with your doctor. So, you want to get in and take a look at your portfolio and see if you are on the right track. Then if you do find some problem spots, the idea is that you want to catch them early and make adjustments to get you back on track towards your plan.
- Is it suited to everyone?
While it is a good idea for everyone, from new investors to retirees, I would say younger investors can more safely take a hands-off approach. The less they look the better. Because if they are primarily invested in stocks, they are going to see some volatility from year-to-year.
As you get closer to retirement that’s when you do want to go in and definitely do an annual portfolio review, see if the portfolio is appropriately positioned relative to your goals. And also check whether you are in fact on track to retire, when you hope to retire.
So once you are in those 5 years towards retirement, that’s really when you want to get in and do a semi-annual review or at a minimum a very good top to bottom annual review.
- How must it be done? Should investors be checking individual holdings or the portfolio as a whole?
Move from general to specific.
So when you do your portfolio review the first question you want to ask is, am I on track to meet my goals? And there are certainly lots of tools on the web that you can use to gauge your readiness toward a given goal.
So if you are someone who is still in accumulation mode and you think, well it looks like I'm not doing as well as I hoped I would, you can kick up your savings rate. You can take steps to adjust your programme to make sure that you hit your goals. So that’s the first thing to go through.
The next step is to look at your portfolio's asset allocation. You want to look at the stock bond cash mix relative to whatever target you are using for your plan.
The next step is to check up on your sub asset allocation. So look at your portfolio's dispersion within the Morningstar Style Box, for example.
If you have fixed income holdings, look at how your portfolio is apportioned between higher quality bonds and lower quality bonds as well as its interest rate sensitivity.
Then the final issue is to do that checkup on individual holdings. Focus not so much on performance even though it's hard to ignore. But really take a look at the fundamentals of those holdings: Have we seen big changes? Have we seen a management change? Have we seen a change in the portfolio that runs counter to what I expected the holding to do?
So that holdings level checkup should come last in the queue, assuming that people have a finite amount of time to devote to their portfolio checkup. That would be the relatively smaller portion of the checkup.
- Under what conditions should investors consider rebalancing? If the portfolio is off by 2%, 3% is there a specific guideline?
I usually say if you want to be hands-off, look for divergences of 10 percentage points relative to your asset allocation targets. So if you have seen a great run-up in your equity holdings and they have exceeded 10% and are higher than your target for them, then scale them back.
For most people though I think a 5 percentage point divergence relative to targets should be a catalyst for rebalancing. So you are stripping back on what has performed well and is taking up a bigger share of your portfolio than you intended it to. The key benefit of that rebalancing is that it helps reduce risk in your portfolio, so rebalancing is definitely a good practice for your portfolio.
But let those triggers guide the way rather than doing it on an annual basis regardless of where you are relative to your targets.
