Annual Checkup Means Healthy Portfolio

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Everyone knows an annual physical is recommended for most adults. Seeing your doctor on a regular basis helps identify potential health problems before they become serious. Your investment portfolio needs an annual checkup, too.

Just like your annual physical, a periodic review of your portfolio can help you avoid unpleasant surprises down the road and keep your financial strategy on track. Here are some tips for fine-tuning your financial checkup!

Know What To Look For

Reviewing a portfolio isn't terribly helpful if you don’t know what to look for. This is where your financial plan comes in. Creating a plan takes some time and thought. But think of it in these terms: This is your future. Do you really want to wing it?

To cover the basics, you'll need to know:

  • Where you are in life
  • Where you want to go
  • How your investments can help you get there
  • How much risk you’re willing to take

With a plan, you'll have a better idea of what your investment portfolio should look like. If a review shows that your portfolio is markedly different from where you think it should be, it's time to take action!

Set It, But Don't Forget It

Most people understand the value of making an initial investment plan. After that, many of them believe their work is done. If you're one of these people, you might want to reconsider! Neglecting to pay regular attention to your portfolio can have negative consequences.

Effective investment portfolios are dynamic. They should change as your circumstances change. For example, your portfolio as a 20-year-old, a 50-year-old, and an 80-year-old will likely look different at each stage! The rule of thumb is that the younger you are, the more risk you can typically take with your investments. Changes in your marital status and parenthood may also call for reevaluating your portfolio.

In addition, you’ll want to keep an eye on your individual investments. Is their performance acceptable? Have there been changes to the management team that could affect performance? Based on your answers, you may want to make replacements.

Keep in mind your investment accounts may grow at different rates over the years. For example, if you consistently contribute to your 401(k) account it will grow at a faster rate than its investment return would initially imply. String together several years of maximum contributions - plus (hopefully) a company match - and your 401(k) could quickly become a major part of your overall net worth. It's wise to pay attention to more than just the account’s balance when you receive a statement!

Finally, portfolios need to be watched because they can get out of whack. Here’s a simplified example of how that can happen:

Suppose you start with $50,000 in a brokerage account and $18,000 in a 401(k). Your brokerage account is invested in a 50/50 mix of stocks and bonds while your 401(k) is 100 percent invested in stocks. This means you have a starting overall allocation of roughly 65 percent stocks and 35 percent bonds.

Let’s say you don’t add any money to the brokerage account, but you add $18,000 per year to your 410k. After 10 years (using the actual returns from the last 10 years of the Standard & Poor’s 500 and the Barclays Aggregate) your brokerage account will have grown to more than $91,000 while your 401(k) balance is more than $348,000. By keeping both accounts invested in the same mix over the 10-year period your overall allocation has gone from 65 percent stocks to 90 percent stocks! With that much in the stock market, a 10 percent market correction would be much more painful than anticipated.

Look at the Big Picture to Stay on Track

The above scenario highlights the necessity of keeping an eye on the overall picture as well as the status of individual accounts. In our example, both the brokerage and 401(k) accounts remained at their targeted allocations, but the growing disparity in their sizes resulted in a large overall imbalance.

Accounts cannot be viewed in a vacuum. They must be looked at as pieces of a bigger picture. Do this and you can avoid unintentional - and sometimes dramatic - shifts in your overall asset allocation. What could you have done to maintain your overall stock allocation? When you noticed your 401(k)’s aggressive growth, you could have lowered the stock allocation in your 401(k) account. Gradually lowering your 401(k) stock investment from 100 percent to 70 percent over the 10-year period would have kept your overall allocation at your target of 65 percent in the stock market.

Summary

Responsibly managing your finances requires ongoing diligence. It isn’t enough to select good investments and then forget about them. Take time to occasionally review your portfolio, both as individual components and as a whole. This will help you avoid some potentially serious headaches in the future!

David Crossman, CFA, is an Investment Manager with Bedel Financial Consulting Inc., a wealth management firm located in Indianapolis. For more information, visit their website at bedelfinancial.com or email David.

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