Why do we take unnecessary risk with our investments? Is it because we’re gluttons for punishment or is it because we’re incredibly brave? Often, it’s because we’re simply distracted or unaware.
Although the Standard & Poor’s 500 index is still hanging on to its year-to-date gain, stock market volatility or the Chicago Board Options Exchange Market Volatility Index, also known as “VIX,” has advanced more than 85 percent over the past three months. Usually, during times of rising volatility, like now, people begin to notice financial risk inside their portfolios. And it becomes a problem when our portfolio’s risk level is incompatible with our true risk capacity.
My latest portfolio report card is for M.T. in Cave Creek, Arizona. He’s 45 years old, married and he works in pharmaceutical sales. He asked me to analyze and grade his self-managed $569,742 portfolio. It’s divided between an individual retirement account ($563,554) and a 401(k) retirement plan ($6,188).
He told me he’s been able to accumulate over half a million dollars in retirement savings because “I have had very generous employers and I have always saved the percentage up to the company match since 1991.” Also, his IRA balance is a result of several 401(k) rollovers at previous jobs.
He owns 13 mutual funds, nine exchange-traded funds, and one individual stock in Healthcare Property Investors, Inc. What type of portfolio report card will M.T. get? Will it be an A, B, C, D or F? Let’s analyze his holdings together and find out.
| $569,742 Portfolio Asset Mix | |
|---|---|
| Stocks | 60% |
| Real Estate | 9.5% |
| Bonds | 26.6% |
| Commodities | .40% |
| MT’s Largest Positions | |
|---|---|
| Loomis Sayles Bond (LSBRX) | $78,181 |
| Hennessey Gas Utility Index Inv. (GASFX) | $59,978 |
| Berwyn Income (BERIX) | $57,975 |
| Dodge and Cox Intl. Stock(DODFX) | $46,742 |
| Baron Real Estate Fund (BREFX) | $44,504 |
| Utilities Select Selector SPDR (XLU) | $43,007 |
| PIMCO Income D (PONDX) | $40,138 |
| PowerShares Intl. Dividend (PID) | $38,090 |
| PIMCO Foreign Bond (PFODX) | $30,746 |
| SPDR DJ Intl. Real Estate (RWX) | $28,813 |
Cost. All well-built investment portfolios aim to minimize brokerage commissions, fund fees and other costs to the greatest degree possible.
Although it’s good to see M.T. owns a few low-cost funds and ETFs like the Schwab S&P Index 500 and Utilities Select Sector SPDR ETF, he still owns a few funds like Loomis Sayles Bond Fund, Lazard Emerging Markets Equity Portfolio and Baron Real Estate Retail, with elevated annual expenses. On portfolio cost, M.T. definitely has some fat to trim.
The combined annual fund expenses for M.T.’s IRA and 401(k) portfolio is 0.68 percent. A blended benchmark with an asset mix of index ETFs that matches his unique investor personality is 0.22 percent or three-times less expensive.
Diversification. A properly diversified portfolio always has exposure to all of the major asset classes, not just the ones your personal bias favors. M.T.’s overall asset mix is 60 percent in stocks (international and U.S.), 26.6 percent in bonds (international and U.S.), 9.5 percent in real estate and 3.9 percent in commodities.
Though it seems he’s made an attempt at diversifying, I don’t see enough exposure to broadly diversified funds that serve as acceptable proxies for the core asset classes. For example, he owns Schwab S&P Index 500, Vanguard Small-Cap Value ETF, SPDR Dow Jones International Real Estate ETF and Schwab U.S. Mid-Cap ETF — all OK choices. But sadly, these funds represent a very small portion of his overall portfolio, when in reality they should be the core or foundation.
Risk. M.T. describes his investing style as somewhere between moderate and aggressive. Much of his money is oriented toward dividend-income funds or sectors, such as utilities (Hennessy Gas Utilities Index Fund), real estate (Baron Real Estate Retail), and dividend stocks (PowerShares International Dividend Acheivers).
Based on my assessment, his overall asset mix of 60 percent stocks, 26.6 percent bonds, 9.5 percent real estate and 3.9 percent in commodities matches up with his risk character. It’s also compatible with his age and life circumstances.
Tax-efficiency. It’s good to see that M.T. hasn’t destroyed the tax benefits of his tax-deferred retirement plans by taking out premature distributions. Also, he has no outstanding 401(k) loans which could pose a tax threat to his money if he suddenly leaves his current job. Overall, M.T.’s portfolio does well on tax-efficiency.
Performance. In September 2013, M.T. had a combined balance of $502,000 and one year later, his account balance has grown to $569,742. When we adjust his performance for the $18,720 he stashed away over the past year, he gained 9.8 percent.
By comparison, our yardstick for performance delivered a 1-year return of 16.5 percent, while he underperformed by 6.7 percent. M.T.’s unsatisfactory performance is a clear consequence of deficiencies in his previously graded categories.
The final grade. M.T.’s final portfolio report card is a C. This means M.T.’s portfolio has serious structural flaws that make it unsatisfactory. His retirement portfolio’s weakest points are cost, diversification and performance.
On a positive note, M.T. is an excellent saver. He also appears to be coachable and willing to take the steps required to improve his investment results. Ultimately, I’m confident he’ll reach his goals, but only if he focuses on addressing the shortcomings of his current portfolio.
Ron DeLegge is the Founder and Chief Portfolio Strategist at ETFguide. He’s inventor of the Portfolio Report Card which helps people to identify the strengths and weaknesses of their investment account, IRA, and 401(k) plan.
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Portfolio Analysis: A $569,742 Retirement Plan With Sluggish Performance originally appeared on usnews.com
