Finance Review diversification/asset allocation Most retirees are best served by a properly diversified portfolio that includes a range of assets (cash, bonds, stocks, real estate, precious metals, etc.) with different characteristics (small- and large-company stocks, foreign and domestic equities, growth vs. income investing objectives, etc.). The idea is simple: by putting your eggs in many baskets, you’ll be protected if any one of those eggs “breaks.” In some years, your allocation won’t change all that much. In others, strong performance (or underperformance) will throw it a little out of whack. Over the course of many years, even slight misalignments can eventually result in an oversized allocation in a given investment or asset class that exposes you to more risk than you’re comfortable with. That’s why you should spend some time reviewing your current allocation against the “baseline” which you established in your financial plan. If the two are substantially different – say, five per cent above or below your baseline allocation – trim back any investments that are above your baseline and use the proceeds to boost positions that are below. Don’t knowwhat your baseline allocation is? Again, it’s probably a good idea to put the checkup on hold while you work on figuring this out. Common missteps As simple as a portfolio review is, it’s easy to get things wrong, or focus on the wrong things. Here are some of the most common missteps when conducting your portfolio review. Getting complacent with winners If it’s been a while since you’ve checked up on your portfolio, you may be surprised at how it’s grown in value. This is particularly true if you hold a substantial position in equities (or equity funds), which have performed reasonably well over the past several years. In such a case, the natural inclination is to carry on – after all, if it ain’t broke, why fix it? Some investors may even be inclined to trim back defensive or “steady eddy” investments and add to those that have been outperforming. In some cases, solid performance can even lead to behavioural change…a desire to bump up your portfolio withdrawal rate, for example, or splurge on that special something that you’ve had your eye on for a while. Unsurprisingly, these actions can lead to additional risk – maybe not right away, but down the road.That’s why it’s important to give your winners the same degree of scrutiny as investments with which you’re not happy, and trim themback if they’ve grown to a point at which they’re dominating your portfolio. Overreacting (to winners or losers) For many investors, reviewing portfolio performance can be an emotional experience. They feel great joy with positions that have performed well, and great anxiety (or even depression) at those that haven’t. To some degree, those emotions are perfectly natural. But they can lead to irrational decisions based more on how you “feel” about your portfolio, rather than a dispassionate, reasoned analysis of the given opportunity or risk. Ultimately, relying on emotions for your financial decision-making can lead to poor performance, as you buy high/sell low instead of the opposite. Somake sure to keep stock of your emotions as you move through the portfolio checkup. Ultimately, your buy/sell decisions should be based on an in-depth consideration of performance and long-term trends, rather than a “gut reaction” to short-term gains or losses. No, that’s not always possible. But it’s what we should all strive for. Thinking you have to do something A portfolio checkup can sometimes result in a bias for action – a desire to “do something,” or a tendency to tinker around the edges of the portfolio, making little changes here and there in the expectation that these will produce big results. That’s understandable. With an overwhelming amount of financial data and news coming our way every day, it can often seem as if we should act on that information. However, the world’s greatest investor, Warren Buffett, actually believes the opposite. In fact, according to Buffett, inaction is actually the secret to investment success: “The trick is, when there is nothing to do, do nothing,” he says. Always remember that the goal of your portfolio checkup isn’t action – it’s knowledge. Don’t assume that you have to do anything once you’ve gathered the information. Often times, the best action to take is no action at all. Ignoring taxes Often, changes in allocations and sell decisions can trigger unintended tax consequences. That’s not a problem in tax-sheltered accounts such as RRSPs, RRIFs and TFSAs. But in non-taxable accounts, selling a position that has enjoyed a substantial gain can leave you with a big tax bill. This is not necessarily a problem if you’re prepared for it. But, if you aren’t, it can result in a nasty surprise come April 30. This is not to say that you should let a potential tax bill dictate your allocation decisions – taking money off the table after a big gain is often a prudent decision. But it’s something to keep your eye on. If your gain is big enough, or if your financial situation is complex enough, it’s wise to seek the guidance of a professional tax advisor. Depending on your personal situation, there may be strategies available that can help you minimize the blow. 38 | www.snowbirds.org
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