Your investment portfolio is nothing more than a reflection of who you are. In other words, it’s a personal statement about how you approach financial risk, investment cost, diversification and taxes. If you’re disorderly when it comes to these aspects of your investment plan, the unwelcome consequences will be a disorderly portfolio with disorderly results.
This week’s Portfolio Report Card is for LL, a married couple in Dallas. He’s 48 and works in the telecommunications field, and she is a 42-year-old homemaker.
LL’s $850,613 investment portfolio consists of two rollover individual retirement accounts, one Roth IRA, one 401(k) plan and a joint brokerage account. LL told me their investment goal is to have enough money to retire by age 60, and $2 million is their ideal target. LL self-manages their portfolio, and the combined portfolios own 22 mutual funds, 12 individual stocks and cash.
LL is an aggressive growth investor, and he asked me to analyze and grade their combined portfolios.
What kind of grade does LL’s portfolio get? Let’s analyze it together.
| Snapshot of LL’s $850,613 Combined Portfolio | |||
|---|---|---|---|
| His 401(k) | Holdings Ticker | Category | Dollar Amount |
| Vanguard Inst. Index | – | Mid-Cap | $133,205 |
| Vanguard Windsor II ADM | – | Large-Cap | $56,940 |
| Vanguard Small Grw Index Inst. | – | Small-Cap | $104,459 |
| AF Europac Grwth R4 | – | Intl. | $78,309 |
| American Balanced R4 | – | Blend | $22,208 |
| PIMCO Total Return Inst. | – | Bond | $62,799 |
| Money Market | – | Cash | $5,527 |
| Total Value | $463,447 | ||
| His IRA | Rollover Ticker | Category | Dollar Amount |
| Spartan 500 | FUSVX | Large-Cap | $19,951 |
| Fidelity Low Priced Stock | FLPSX | Mid-Value | $14,020 |
| Fidelity Value | FDVLX | Mid-Value | $28,893 |
| Glenmede LC Growth | GTLLX | Large-Growth | $19,959 |
| Lazard Intl. Strategy Equity | LISOX | Intl. | $15,113 |
| Parnassus Core Equity | PRBLX | Large-Cap | $14,981 |
| TCW Total Return | TGMNX | Bond | $10,037 |
| Abbott Lab. | ABT | Equity | $4,737 |
| American Elec. Power | AEP | Equity | $5,758 |
| Automatic Data Proc. | ADP | Equity | $8,884 |
| Chevron | CVX | Equity | $5,334 |
| Exxon Mobil | XOM | Equity | $6,640 |
| GOOG | Equity | $5,626 | |
| Lockheed Martin | LMT | Equity | $5,001 |
| Salesforce.com | CRM | Equity | $6,938 |
| TWTR | Equity | $4,808 | |
| Money Market | Cash | $14,524 | |
| Total Value | $191,204 | ||
| Her IRA Rollover & Roth IRA | Ticker | Category | Dollar Amount |
| Apple | AAPL | Equity | $9,474 |
| Fidelity Balanced | FBALX | Blend | $33,715 |
| Fidelity Value | FDVLX | Mid-Value | $8,576 |
| Fidelity Fifty | FFTYX | Large-Growth | $8,004 |
| Fidelity Intl. Value | FIVLX | Intl. Value | $10,150 |
| Harbor Intl. | HIINX | Intl. | $10,768 |
| Royce Value | RYVFX | Small Value | $8,096 |
| Fidelity Value (Roth IRA) | FDVLX | Mid-Value | $8,248 |
| Money Market | Cash | $5,845 | |
| Total Value | $102,876 | ||
| Her IRA Rollover & Roth IRA | Ticker | Category | Dollar Amount |
| 2 stocks (MSFT and GE) + 4 Stock Funds | $93,086 |
Cost. Deliberately minimizing trading costs, fund fees and other frictional expenses (like fund redemption fees, sales loads and account maintenance fees) are the hallmarks of all well-built portfolios.
The mutual fund holdings in LL’s combined portfolios (with the exception of the 401(k) plan) have an average expense ratio of 0.67 percent. This is 3.5 times higher compared with our index ETF benchmark.
Here’s another way to think about LL’s portfolio costs: If LL averages 8 percent over the next 15 years, they’ll have around $2,187,000 with their current fee structure, compared with $2,341,000 with lower-fee funds. That’s a whopping $154,000 difference! LL needs to do a better job at minimizing investment costs.
Diversification. Portfolio diversification is all about spreading your financial risk across a variety of asset classes instead of plowing your money into one thing.
This portfolio has exposure to U.S. and international stocks, bonds and cash. This is outstanding. However, this portfolio suffers from overdiversification by holding too much of the same thing. Although this portfolio owns different fund ticker symbols, many of the funds have duplicated exposure to large-cap and mid-cap stocks.
Overdiversification happens again in his 401(k) plan and her IRA rollover with exposure to balanced funds, creating needless overlapping exposure to both stocks and bonds already held by other funds in their portfolio.
Finally, the combined portfolios miss exposure to two major asset classes: commodities and real estate.
Risk. A portfolio’s risk character should always be 100 percent compatible with the risk profile of the investor, and it should also be age-appropriate.
The overall asset mix of this total portfolio is the following: 89 percent stocks, 8 percent bonds and 3 percent cash. This is a hyperaggressive asset mix that subjects LL to high volatility and substantial market risk. A 20 percent to 40 percent stock market correction risks this portfolio to potential market losses of $170,000 to $340,000.
Tax efficiency. Smartly constructed investment portfolios should always minimize the threat of taxes.
The tax efficiency for LL’s portfolio is OK. They have not taken any 401(k) loans or premature retirement plan distributions.
However, on taxable brokerage side, almost $60,000 is invested in actively managed mutual funds, and their tax-efficiency could be improved by simply owning more tax-efficient funds like index mutual funds or exchange-traded funds.
Performance. How an investment portfolio performs will either validate or incriminate its design. How did LL do?
The combined portfolios gained 9.8 percent from February 2014 to February 2015, compared with a 12.61 percent gain in a blended index benchmark that matches their same asset mix. LL underperformed our index benchmark, and their performance was unsatisfactory. Remember: Performance should match or exceed index benchmarks.
The final grade. LL’s final Portfolio Report Card grade is “C” (weak). This portfolio’s weakest grading categories are diversification, risk and performance. The strongest grading category is tax efficiency.
The overall asset mix of 89 percent stocks, 8 percent bonds and 3 percent cash is hyperaggressive and is not age-appropriate.
Diversification is uneven, with parts of the portfolio being overdiversified and other parts being underdiversified. Also, LL misses two major asset classes and yet still makes room to invest in individual stocks. Buying individual securities shouldn’t happen until your portfolio is first fully and properly diversified.
In summary, LL and his wife are good savers, and with a few tweaks, they can become even better investors.
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Portfolio Analysis: a Subpar-Performing $850,613 Investment Account originally appeared on usnews.com
