Monitoring Your Portfolio Investment Portfolio

12.1 Regular Checkups

We have talked about some of the biggest mistakes investors can make- chasing hot funds, paying too much, and not having a diversified portfolio. You could avoid all those mistakes, but if you fail to monitor and periodically adjust your portfolio, you might still have only limited success as an investor.

You have determined just the right mix of assets and have chosen solid funds to fill those roles. But they won’t just stay in one place. You will need to rearrange your portfolio precisely because it’s a mix of different kinds of investments, which will perform differently over time. Take one of the fundamental portfolio splits, stocks versus bonds. Stock returns usually outpace those of bonds over long stretches, so over time the proportion of stocks in your portfolio will grow.

So what? That means your stocks are prospering. It may seem foolish to cut back on a winner. But the more you let winners run, the greater the risk in your portfolio. Imagine that you invested in an ideal portfolio was a 50:50 mix of stocks and bonds. To simplify things, you put Rs.100000 in Nifty Index and Rs.100000 in Bond Index. If you then let them ride for five years, and potentially with markets going up- you could have earned 69% in stocks and 31% in bonds.

This is a lot of money made, but an additional 19% of your portfolio is vulnerable to a downturn in stocks. If you had hold on to this portfolio- if the stock market drops, your portfolio would also loose. However- if you rebalance your portfolio- to ensure it’s a 50:50 split then the loss would be lower.

The asset mix you came up with originally was the best one for meeting your goals. If that gets out of whack, then you don’t have the right portfolio for you anymore-it makes sense to restore the mix. Still, rebalancing can be challenging. It requires you to take money from your best-performing funds and divert it to the ones that are lagging and may even be losing money. If you shift money from your strong-performing stock funds to bond funds, though, you aren’t selling off everything; you’re protecting the gains that you made by effectively taking some of them off the table. Alternatively, if your stock funds are in the red and you shift money from your bond funds, you’re getting more shares on the cheap, which can enhance your returns.

12.2. Knowing When to Rebalance

The common rule is to rebalance your portfolio once a year. Just choose a date such as 1^st April (or maybe a different date like 1^st Jan) and review and rebalance your portfolio then. You could rebalance your portfolio more often, but more frequent rebalancing, such as every three or six months, doesn’t do much to limit volatility. And if you’re rebalancing funds in a taxable account, frequent selling could be bad for your tax planning because you’re typically taking profits on your winners.

Before rebalancing you need to determine what is out of balance. That’s why you should start with an annual portfolio review. You will want to check the percentage of your portfolio that is devoted to the following areas:

• Cash, stocks, and bonds.
• Various investment styles, such as “large value” or “small growth.”
• Key sectors
• Specific individual securities

Asset Mix:

You’ll probably find that your mixture of cash, stocks, and bonds shifts the most dramatically over time. Stocks typically post better returns than bonds or cash, and therefore continue to grow in importance in your portfolio if left untouched. When the market is in the doldrums, the opposite may be the problem: Your stock portfolio loses money, leaving your equity allocation smaller than you’d like. Either way, it’s important to pay close attention to the balance of stocks, bonds, and cash, and to be ready to readjust as necessary to meet your approaching goals.

If your stock funds are taking up more than their allotted share of your portfolio, trim them back and shift the money to bonds. If you are investing in a taxable account, cutting back on stocks could mean incurring a taxable gain. Instead of selling stocks, you may want to invest new money in your bond funds to restore the balance.

The simple step of restoring your stock and bond mix is the most important thing you can do to keep your portfolio’s volatility in check and to protect the gains you have made. Excessive stock exposure will make your portfolio much more vulnerable to stock market slumps. At the other extreme, parking too much in bonds will hinder you from getting the long term returns you need to meet your goals.

Investment Style:

Just as your stock/bond mix can change, your portfolio’s investment style can also shift over time. In a given year, different kinds of stock funds can perform very differently from each other-that’s the reason you want to hold a variety of stock funds in your portfolio.

Your portfolio mix can shift for other reasons, too. Your managers may have decided to emphasize growth stocks, even if they don’t run growth funds, because that part of the market is too compelling to overlook. Industry trends could also cause stocks that are typically growth investments to gravitate toward value, or vice versa. As discussed earlier, a good mix of both growth and value can protect you from dramatic downturns in any given style.

Sector Exposure:

It’s also important to be mindful of your exposure to specific sectors and to rebalance to avoid getting burned by a single area. After technology stocks came into vogue in 1998 , investors who were previously well diversified among a handful of mutual funds discovered that a large chunk of their assets were actually directed toward just two sectors: computer hardware and software. A portfolio made up of the seven preceding popular funds would have had more than 50% of its assets in the information supersector, with especially heavy stakes in the computer hardware and software sectors. Focusing on one or two areas of the market might pump up your returns temporarily, but it will also leave you dangerously exposed to downturns in those areas, as the experience of those seven funds illustrates. Conduct a regular checkup of your sector exposure, and consider scaling back on those funds that are skewing your portfolio heavily toward a certain sector.

Concentration in Specific Securities:

Letting your portfolio concentrate heavily in a few stocks can also ruin your plans.Checking on “stock overlap,” as it’s called, will help to ensure that you don’t inadvertently go into one year with 30-40% or more of your assets dedicated to the best-performing stock of the previous year, which could be ready for a downturn.

To accurately assess the largest stock positions in your portfolio, you’ll need to add together any individual stocks you own and any exposure from the top holdings of your mutual funds. It’s not unusual to discover that many of the most popular mutual funds are investing in the same securities. Additionally, if you invest in overlapping funds, you could end up paying for that duplication of effort with greater portfolio volatility.