Finance Problem: portfolio returns aren’t keeping up with the market We all want to see our wealth grow over time. But, when we notice that our returns aren’t keeping up with the broader market, we can sometimes feel as if we’ve missed out on something − that we’re doing something wrong or not getting what we paid for with our investments. This emotional reaction can lead to a whole host of other problems: we might make riskier investments or ignore long-term planning goals, all in a misguided effort to “beat” a benchmark or goal that we’ve set for ourselves, or make up for some of those “lost” returns which we think we’ve missed out on. Problem: you haven’t taken a close look at your portfolio in some time You knowwhat happens if you don’t mow your lawn or weed your garden: pretty soon, it becomes an overgrown tangled mess. The same thing can happen to your portfolio. While there’s nothing wrong with a “buy and hold” strategy, if you neglect to trim, prune or weed the positions in your portfolio, it could become overgrown with risk. Failure to check in on your investments on a regular basis may cause you to miss business and economic events that may significantly impact your holdings. And, over time, the routine ups and downs of the market might throw your portfolio out of whack with your allocation objectives or your risk tolerance. Solution: set up a regular portfolio checkup schedule Much like you tend your garden on a regular basis, you should schedule routine portfolio checkups, too. How often? Well, routine market-watchers might want to check in every week, or even every day. For those of us who are more hands-off with our investments, a quarterly checkup is probably a good rule of thumb, with additional “emergency” checkups if a market-shaking event strikes (the meltdown of last March would be a prime example). This doesn’t mean that you should always take action. But, at the very least, it will force you to actively monitor your positions, and help you identify small problems before they become big ones. Problem: risk is “creeping” into your portfolio A significant problem, although one that can be hard to see until it’s too late. Even novice investors understand that the various holdings in their portfolios will rise and fall in value in any given year. But, in times of continued broad-market strength (such as what we’ve experienced since March of last year), risky bets can seem a lot less risky than they really are − if everything is going up, you don’t really notice the potential for loss. Over time, however, this kind of complacency can mean that your portfolio “creeps” away from a level of risk with which you’re comfortable. It’s only after the position drops by 20%, 30%, 50% or more in a few short weeks that you realize that perhaps you aren’t really cut out for “theme stocks,” high-flying tech startups or other high-risk/ high-return investments. Solution: do an honest assessment of your risk tolerance and trim, if necessary If it’s been a while since you’ve assessed the “riskiness” of your portfolio holdings, it’s time to do so. One way is to run through various “what if ” scenarios, in order to get a better idea of exactly how much of a loss you’re really comfortable with. If you start to cringe a bit at a particular dollar figure − and you should think about it as a dollar figure instead of a percentage, which tends to be more abstract − then you know that you’ve reached your limit, and it’s time to trim back those risky bets. The key word here is honest. If you’re not truthful about your appetite or limit for risk, or if you try to convince yourself that you’re “stronger” than other investors, or that you can control your emotions under a highstress market crash in which the value of your holdings drops by 33% in the space of a month (about the size of the market drop inMarch of last year), you may be in for a very rude awakening if one of those “what if ” scenarios becomes reality. Solution: think about risk-adjusted returns Performance is all well and good but, to get a real understanding of how your portfolio is doing, it’s better to focus on risk-adjusted performance − that is, howmuch performance are you getting compared to how much volatility you have to accept in order to get it. (Remember: there is no such thing as truly “risk-free” performance.) There are many ways to measure risk-adjusted performance; some common ones include alpha, beta, R-squared, standard deviation, and the Sharpe ratio (named after the Nobel Prize-winning economist who invented it). There are many online tools and websites that allow you to track at least some of these measurements. Getting familiar with them allows you to get a true measure of the performance of your portfolio, so you canmake apples-to-apples comparisons to whatever benchmark is most appropriate. One final word about performance comparisons: we’d question how much attention investors should really be paying to them at all. For many investors, beating a benchmark is just a way of bragging about one’s portfolio − an emotional response that completely misses the point of investing. Instead of trying to beat a benchmark, ask yourself: have you earned enough to fund a high quality of living for the rest of your life? Do you have enough money to cross items off of your bucket list? Will you have enough to leave a meaningful financial legacy for your family? These are the real benchmarks against which you should be judging your portfolio. 24 | www.snowbirds.org
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