It’s commonly and incorrectly presumed that people with large investment portfolios are smart investors. But as counterintuitive as it may sound, this false presumption is simply not true. How do I know?
Because I’ve analyzed and graded many multimillion dollar investment portfolios ($27 million is the largest one I’ve graded so far this year) using my Portfolio Report Card grading system — and many of these very portfolios have flunked on cost, risk, diversification and performance.
What’s the basic translation? Being a good saver doesn’t automatically make a person a good investor. On the other hand, combining a good savings habit along with a militant approach toward investment costs, risk, diversification and taxes should lead to the satisfactory performance you seek.
My latest Portfolio Report Card is for a married couple, SMB, living in Houston. Both are in their early 50s and they asked me to grade their combined $1.29 million investment portfolio that consists of two traditional IRAs, two Roth IRAs, a Roth 401(k), a 403(b), a 401(k) plan and a brokerage account.
SMB told me they are aggressive growth investors and generating income is a low priority at this stage of their investment plan. The entire $1.29 million portfolio is self-managed.
What kind of grade does SMB’s portfolio get? Let’s analyze it together.
| Snapshot of SMB’s $1.29 Million Portfolio | |||
|---|---|---|---|
| His IRA Holdings & 401(k) | Ticker | Category | Dollar Amount |
| Vanguard Dividend Growth | VDIGX | U.S. Large Blend | $65,335.71 |
| Vanguard Growth | VIGAX | U.S. Large Growth | $328,300.71 |
| FMI Large Cap | FMIHX | Intl. Stocks | $98,975.49 |
| PRIMECAP Odyssey Aggressive | POAGX | U.S. Mid Growth | $97,844.08 |
| Vanguard Selected Value | VASVX | U.S. Mid Value | $69,742.02 |
| Oakmark International | OAKIX | Intl. Stocks | $32,217.57 |
| American Funds Europacific Growth | RERGX | Intl. Stocks | $127,465.95 |
| Vanguard Institutional Idx | VINIX | U.S. Large Blend | $49,459.40 |
| T. Rowe Price New Horizons | PRNHX | U.S. Small Growth | $52,540.32 |
| Total Value | $921,881.25 | ||
| Her IRA Holdings & 403(b) | Ticker | Category | Dollar Amount |
| GuideStone Funds Equity Index | GEQZX | U.S. Large Blend | $24,703.35 |
| Vanguard Energy | VGNEX | Sector | $10,670.19 |
| Vanguard Intl. Growth | VWIGX | Intl. Stocks | $21,571.16 |
| Vanguard Primecap | VPCCX | U.S. Large Growth | $35,838.20 |
| Cash | — | Cash | $88,999.04 |
| Total Value | $181,781.94 | ||
| Her Brokerage Acct. Holdings | Ticker | Category | Dollar Amount |
| Vanguard 500 Index | VFIAX | U.S. Large Blend | $114,678.05 |
| Vanguard Dividend Growth | VDIGX | U.S. Large Blend | $25,012.11 |
| Vanguard Intl. Value | VTRIX | Intl. Stocks | $31,953.11 |
| Vanguard Strategic Equity | VSEQX | U.S. Mid Cap | $16,855.38 |
| BP | BP | Individual Stock | $6,366.29 |
| Total Value | $194,864.94 | ||
| Total Portfolio Value | $1,298,528.13 |
SMB’s combined portfolio holds 17 mutual funds, one individual stock and cash. The asset-weighted annual fund expenses on the mutual funds are 0.39 percent versus 0.20 percent for our index benchmarks. Put another way, SMB’s fund costs are almost twice as high versus the benchmark. This portfolio still has too much fat. Time for a diet!
Cost. The investment costs you bear today compound over time and will erode your investment returns. And that’s why reducing the negative impact of trading commissions, fund fees and other frictional costs is something the prudent investor carefully does.
Diversification. A truly diversified investment portfolio will always have broad market exposure to the five major asset classes — stocks, bonds, commodities, real estate and cash. How does SMB’s portfolio do?
SMB’s portfolio owns mutual funds investing in U.S. stocks, international stocks and cash. However, the portfolio misses direct exposure to major asset classes such as bonds, commodities and real estate. Put another way, SMB has a two-asset class portfolio that comes up far short of being genuinely diversified.
Risk. Your investment portfolio’s risk character should always be 100 percent compatible with your capacity for risk and volatility along with your unique financial circumstances, liquidity requirements and age.
The overall asset mix of SMB’s combined portfolio is 92.2 percent stocks and 7.8 percent cash. This asset mix tilts on the hyperaggressive side for aggressive investors in their early 50s. Put another way, a market decline of 20 percent to 40 percent would subject the total portfolio to potential market losses of $208,000 to $416,000.
Tax efficiency. What you sow is what you reap — and a smartly designed investment portfolio takes proactive steps at cutting the threat of taxes. Owning tax-efficient investment vehicles and having proper asset location are two easy steps.
About 85 percent of SMB’s portfolio is invested in tax-deferred retirement accounts and they have no outstanding loan balances or premature retirement distributions that have increased their tax bill.
Their taxable brokerage account has exposure to Vanguard stock funds with reasonable tax-cost ratios. Overall, SMB’s portfolio does outstanding at tax efficiency.
Performance. Investment performance will always reveal whether an investment portfolio is architecturally strong or weak. Satisfactory performance is a direct result of controlling cost, taxes, risk and diversification.
SMB’s portfolio grew $91,159 (8.1 percent) from June 2014 to June 2015, versus a gain of 9.1 percent for the index benchmark matching their same asset mix. Although they slight underperformed the benchmark, it wasn’t by much and their portfolio’s one-year performance is satisfactory.
The final grade. SMB’s final Portfolio Report Card grade is “B” (good). They scored best in the following categories: tax-efficiency and performance.
However, this portfolio flunked in the risk category. Their 92 percent exposure to equities isn’t age appropriate and is well beyond just aggressive — it’s hyperaggressive! SMB’s margin of safety is nonexistent and a market decline of 20 percent to 40 percent market decline would subject their portfolio to significant market losses.
Likewise, a lack of diversified exposure to major asset classes like real estate, commodities and bonds is a missing ingredient.
What about cost? Although SMB owns several low-cost index funds, the higher cost funds they own unnecessarily elevate the total portfolio’s fund expenses. Cutting investment cost further should boost SMB’s long-term net returns.
Will SMB take corrective action to fix the weaknesses in their portfolio? For their sake, let’s hope so.
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Portfolio Analysis: a Hyper-Aggressive $1.29 Million Portfolio With Holes originally appeared on usnews.com
