A few months ago, the Nasdaq Composite Index eclipsed 5,000 for the first time since March 2000. Put another way, we are all 15 years older since the Nasdaq’s first dance with all-time highs, but are we smarter? What did we learn from the first meltdown that can help us cope with future meltdowns?
After analyzing more than $100 million in investments with my Portfolio Report Card grading system, I can confidently say that unsuitably risky portfolios for people at or near retirement are once again a reoccurring theme. Will history repeat itself?
This time around, the same kind of aggressive risk-taking that characterized the investing public in the late 1990s and again the mid-2000s is being aped once again. The main difference is that everyone is 15 years older and investment time horizons are shorter.
My latest Portfolio Report Card is for a married couple, “JPG,” living in Maryland. Both are in their late 60s, and they asked me to grade their combined $1.31 million investment portfolio, which consists of two traditional individual retirement accounts and a joint brokerage account.
JPG explained to me they are not aggressive investors and want to have portfolio growth, but they need investment income to meet their daily living needs.
JPG’s portfolio is managed by a financial advisor who charges 0.89 percent annually. Do they have a healthy or unhealthy investment portfolio?
Let’s do a Portfolio Report Card for JPG and find out.
| Snapshot of JPG’s $1.31 Million Portfolio | |||
|---|---|---|---|
| His IRA Holdings | Ticker | Category | Dollar Amount |
| Apple | AAPL | Individual Stock | $13,178 |
| Guggenheim BulletShares 2016 | BSCG | Bonds | $24,875 |
| Chevron Corp. | CVX | Individual Stock | $41,296 |
| Guggenheim Defensive Equity | DEF | Global Stocks | $88,662 |
| Disney | DIS | Individual Stock | $31,390 |
| General Electric | GE | Individual Stock | $3,999 |
| iShares MSCI Emerging Mkts | EEM | Emerging Mkts | $24,081 |
| iShares Nasdaq Biotech | IBB | Sector | $25,542 |
| iShares Select Dividend | DVY | Large US Stocks | $172,366 |
| PowerShares Intl Dividend | PID | Intl. Stocks | $90,400 |
| PPL, Corp. | PPL | Individual Stock | $20,880 |
| HealthCare Sector SPDR | XLV | Sector | $7,513 |
| Technology Sector SPDR | XLK | Sector | $54,394 |
| SPDR S&P Dividend | SDY | Large US Stocks | $63,208 |
| Southern | SO | Individual Stock | $9,572 |
| Cash | — | Cash | $3,999 |
| Total Value | $676,355 | ||
| Her IRA Holdings | Ticker | Category | Dollar Amount |
| 3M | MMM | Individual Stock | $32,174 |
| Guggenheim BulletShares 2016 | BSCG | Bonds | $11,882 |
| Guggenheim Defensive Equity | DEF | Global Stocks | $41,243 |
| iShares MSCI Emerging Mkts | EEM | Emerging Mkts | $11,418 |
| iShares NA Software | IGV | Sector | $17,837 |
| iShares Select Dividend | DVY | Large US Stocks | $86,334 |
| PowerShares Intl Dividend | PID | Intl. Stocks | $55,776 |
| Microsoft | MSFT | Individual Stock | $4,745 |
| SPDR S&P Healthcare Equip. | XHE | Sector | $4,636 |
| SPDR S&P Healthcare Services | XHS | Sector | $19,015 |
| Technology Sector SPDR | XLK | Sector | $19,005 |
| Starbucks | SBUX | Individual Stock | $4,144 |
| Southern | SO | Individual Stock | $8,919 |
| PPL, Corp. | PPL | Individual Stock | $14,442 |
| Cash | — | Cash | $1,043 |
| Total Value | $332,613 | ||
| Brokerage Acct. Holdings | Ticker | Category | Dollar Amount |
| Guggenheim S&P Global Dividend | LVL | Global Stocks | $24,296 |
| Guggenheim Defensive Equity | DEF | Global Stocks | $31,749 |
| iShares Select Dividend | DVY | Large US Stocks | $41,396 |
| Ensco, PLC | ESV | Individual Stock | $3,843 |
| Invesco Unit Investment Trusts | — | Global Stocks | $109,675 |
| Invesco High Yield Munibond | ACTDX | Municipal Bonds | $93,300 |
| Cash | — | Cash | $1,507 |
| Total Value | $305,085 | ||
| Total Portfolio Value | $1,314,734 |
Cost. The prudent investor takes deliberate steps to minimize the negative impact of trading commissions, fund fees and other frictional costs to the greatest degree possible. For income-oriented investors that are retired like JPG, cutting costs is crucial because it directly impacts their cash flow and lifestyle.
The combined portfolios hold 12 exchange-traded funds, nine individual stocks, two unit investment trusts, one mutual fund and cash. The asset-weighted annual fund expenses on the mutual funds and ETF positions are 0.42 percent, plus another 0.89 percent for advisory fees (1.31 percent total). In other words, JPG spends around $17,200 annually in investment advisory and fund fees, which are almost seven times higher versus a benchmark of index ETFs matching their same asset mix.
Diversification. Genuinely diversified investment portfolios always have broad-market exposure to the five major asset classes: stocks, bonds, commodities, real estate and cash. How does JPG’s portfolio do?
It’s good to see JPG’s portfolio has exposure to U.S. and international stocks, corporate bonds and cash. However, the portfolio has overdiversified exposure to health care and dividend-paying stocks by owning multiple funds that invest in the same area. Instead of helping JPG’s portfolio, it has created a situation of unnecessary clutter.
Unfortunately, JPG’s portfolio lacks a core foundation that’s built on investments that are broad proxies of the asset classes where they invest. For example, although they own a corporate bond fund (BSCG), it’s not the type of holding that gives them complete coverage of the bond market. The same is true of their equity ETF holdings.
Additionally, JPG’s portfolio misses exposure to two major asset classes: real estate and commodities. For an advisor-managed portfolio to have diversification this sloppy is unacceptable.
Risk. Financial risk is a loaded subject, so let’s simply it for you: The risk character of an investment portfolio should always be 100 percent compatible with a person’s capacity for risk and volatility along with his or her unique financial circumstances, liquidity requirements and age.
The overall asset mix of JPG’s combined portfolio is the following: 96.5 percent stocks, 3 percent bonds and 0.5 percent cash. Is this asset mix compatible with JPG?
This asset mix is hyperaggressive from two angles: First, it’s not compatible with how JPG described themselves as balanced income investors, and second, exposure of 96.5 percent equities is not age-appropriate for late-60s investors.
The current asset mix in a 20 percent to 40 percent market decline would subject the combined portfolios to potential market losses of $249,000 to $500,000. What kind of anguish and radical lifestyle changes would losses of this magnitude cause JPG?
Tax efficiency. Well-built investment portfolios are always aggressive at cutting the threat of taxes. This can be accomplished by owning tax-efficient investment vehicles along with proper asset location.
JPG told me their plan is to defer paying taxes on their IRAs by waiting a few more years to draw on their retirement funds until mandatory required distributions kick in at age 70 1/2. This is a good strategy, and hopefully market returns will reward their patience.
Their taxable brokerage account has exposure to municipal bonds that generate tax-free income, which shows some semblances of an attempt to reduce the negative impact of taxes.
Performance. Investment performance will either validate or invalidate your portfolio’s design. And satisfactory performance is a direct result of controlling cost, taxes, risk and diversification.
JPG’s portfolio gained $38,497 and grew 3.1 percent from May 2014 to May 2015, compared to a gain of 10.64 percent for the index benchmark matching this same asset mix. Sadly, JPG’s one-year performance return was substantially less and is unsatisfactory.
The final grade. JPG’s final Portfolio Report Card grade is “D” (poor). Although tax efficiency was their strongest grading category, their portfolio flunked in three other key categories: cost, risk and performance.
The fact that a portfolio like JPG’s with such high equity exposure (96.5 percent) performed so poorly during a period of strong performance in the stock market is shocking and confirms this $1.31 million portfolio has significant flaws.
Ultimately, JPG’s diversification is sloppy, misses major asset classes like real estate and lacks portfolio building blocks with broad coverage. The advisor who assembled this portfolio hasn’t earned his or her fees and should be ashamed of the shoddy work.
In summary, if JPG fixes the weaknesses within their portfolio that we identified, it’s hopeful that satisfactory performance with lower risk and cost will follow.
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Portfolio Analysis: a $1.31 Million Portfolio That Flunks on Cost and Risk originally appeared on usnews.com
