The Assessment of your Investment Portfolio in 6 Steps
Regular portfolio reviews are critical to the success of your investments, especially after volatility in the stock, bond, and currency markets. Unfortunately, many expats never get around to reviewing their portfolios, or if they do, they don't approach the process in a sensible way that will give you (better) results over time.
It's not about trying to time the markets or pick the next top stock. Instead, the primary purpose of this portfolio monitoring is to keep things on track, identify problems early, and ensure that your overall investment plan remains focused on your financial goals. Ideally, you will already have a financial plan in place, identified specific, quantifiable goals and a clear idea of how your investment portfolio will support those goals.
How often should you look at your portfolio?
It is certainly not necessary to check your portfolio every day, every week or even every month, quarterly or half-yearly will suffice. This is to ensure that things stay on track without becoming an unnecessary burden.
Follow the steps below when assessing your portfolio. They keep you focused on the aspects most important to manage and help you save time with a focused, systematic approach.
1. Make sure your asset allocation is on track
This is one of the most important aspects to assess, as the distribution between cash, fixed income and equities will largely determine the long-term returns you can expect, the volatility you will experience along the way and how likely it is that you will achieve financial goals.
The weightings assigned to these asset classes should be set out in your financial plan and, if you work with an advisor, should be described in an investment policy statement. Verify that your current weights are in line with your plan. There is no need to make changes for a few percentage points and then incur excessive costs and/or taxable profits. However, if your current weights are off by more than 5%, it's probably time to make some adjustments.
Look not only at the broad distribution between cash, fixed income, and equities, but also at the weightings for each asset class in your portfolio. Not all asset classes have the same volatility or risk/reward profile. For example, the expected return for emerging market equities may not differ much from developed market equities, but the volatility is nearly twice as high. While adding uncorrelated asset classes to a diversified portfolio can improve the risk-return profile, you still want to ensure that some of the more volatile asset classes in your portfolio, such as emerging markets and small-cap stocks, do not outweigh. In general, you want to avoid increasing volatility and risk in your portfolio without much improvement in the portfolio's expected return.
2. Check your currency exposure
This is especially important for expats. By currency exposure we mean the portfolio's underlying economic exposure, not just the portfolio's cash position or reporting currency. For example, if you buy bonds in Australia in a USD-denominated portfolio, the reporting currency will be USD, but the actual currency exposure affecting investment returns will be AUD. Similarly, if you buy large-cap European stocks, you get the returns on those stocks, but you also have exposure to the EURO. It doesn't matter if the portfolio containing these stocks is reported in USD, EUR, or any other currency.
To avoid a currency mismatch, it is important to try to identify what financial goals or future obligations the portfolio needs to fund.
The portfolio currency and asset mix can also be identified in your financial plan and, if you work with an advisor, detailed in your investment policy statement. Verify that the currency remains consistent with the currency of the future liabilities your portfolio needs to fund. This is especially important for the fixed income portion of the portfolio, where currency volatility can easily outweigh fixed income returns.
3. Check the maturity or interest rate sensitivity of your portfolio
With interest rates still low, they have only one direction to go. And since bond prices fall when interest rates rise, you want to understand your portfolio's sensitivity to rising interest rates. Interest rate sensitivity is typically measured using a concept called "duration," which is measured in years. For example, if your portfolio has an average duration of 4.5 years, you can expect the value of the fixed income portion of your portfolio to fall by approximately 4.5% for every 1% increase in interest rates. The longer the term of your fixed income, the longer the term and the more sensitive it is to interest rate movements.
It is best to avoid fixed-interest terms of more than seven years. To mitigate the impact of rising interest rates, consider limiting your fixed income allocation over the short term (1-3 years) and medium term (3-7 years).
4. Review the fees of your portfolio
Review the fees you pay for each fund or position in your portfolio and calculate the total charges for your portfolio. In general, you shouldn't pay more than 1% on the entire portfolio, and if you're efficient, you can cut costs down to 0.70% - 0.50%.
Controlling costs is key to achieving good long-term investment returns. You can understand why when you consider that long-term real returns (excluding inflation) will average only 3% - 5% for most portfolios. If your portfolio has averaged 8% per year over time, while inflation averaged 4%, the real growth (or growth in purchasing power) of the portfolio is only 4%. Since the portfolio needs to grow by 4% to keep up with inflation, all costs come from the portfolio's real return. A 1% fee is a 25% tax on the portfolio's 4% real return and will significantly reduce the long-term growth and value of the portfolio. Fees of 2%-5% or more typical in the offshore expat investment markets can wipe out between 50% and over 100% of your actual returns.
The quickest and easiest way to increase your portfolio's returns without adding risk is to reduce unnecessary costs. If you pay more than 1%, make sure you have a very good reason.
5. Check if you are maximizing tax-advantaged structures
If you are subject to tax on your portfolio and have tax-advantaged structures in place, make sure you use them wisely. This asset location decision is highly dependent on the investor's unique situation, so it is difficult to apply firm rules of thumb. However, you may want to consider placing high-yield investments or tactical positions in tax-exempt investment vehicles.
Studies have shown that the judicious use of tax-advantaged structures can add up to 1% to an investor's after-tax return. This can be a complicated matter, so you may want to work with a financial consultant to ensure you maximize your situation.
6. Track the performance of your portfolio
Be sure to track and monitor your performance at each review. The emphasis is not so much on the quarterly results, as they are especially useful for highlighting short-term volatility. Instead, focus on what you can expect in the long run, such as building a performance record over three to five years or more.
By tracking your performance over time, you can determine how your portfolio is performing, how much volatility it contains, whether specific positions are contributing as expected or not, and whether you're on track to reach your goals. You should review your portfolio quarterly but take each quarter's performance (good or bad) with a grain of salt. Instead, focus on performance over time and whether you're on track to reach your financial goals. Without performance tracking, you have no data to base decisions on.