Like a stress fracture that goes unnoticed until a critical moment, an investment portfolio can suffer from one or more hairline cracks that, if left untreated, can fracture a wealth strategy amid market volatility. Since the best cure for any injury is early intervention, GOBankingRates spoke with financial experts to identify the most effective overall fixes for the weak spots where portfolio breaks most frequently occur. Read on and learn their solutions to common portfolio shortcomings.
1. Create a Plan
Many investors start saving without a clear objective or financial plan. “Some may view investing as a strategy to pick the hot stock that will provide a significant return in the short run,” said Jim Heard, president and CEO at TrueWealth in Atlanta.
“They may be inexperienced investors in need of education, or they understand the principles of risk and return, yet believe they have the ability to beat the market,” he said. “Often, these investors earn their education the hard way.”
When they believe they can beat the market, investors often become overexposed in concentrated stock positions, which could be risky. Instead, Heard encouraged investors to take a longer view and develop a strategy that accurately reflects their financial goals.
2. Diversify Assets
Asset allocation is by far the most important driver of returns, said Kevin J. Prendergast, chief investment officer at EFG Advisors in Schaumburg, Ill. Meanwhile, many portfolios often include a collection of mutual funds and individual stocks, with little consideration given for how each position affects the investor’s overall risk and return profile.
Before deciding how heavily to invest in stocks and bonds across the foreign, domestic and government-issued markets, said Prendergast, investors must carefully consider their investment objectives as well as how they respond to turbulence in the market.
An effective asset allocation strategy can be designed with a portfolio of exchange-traded funds. Prendergast said that ETFs can provide “extreme diversification at the security level, while allowing investors to achieve precise exposure to each asset class without holdings overlap.”
3. Analyze Risk Tolerance
The ancient Greek aphorism, “know thyself,” is sage advice for all investors regardless of time horizon. “Often times an investor will say they are a conservative investor,” said Dennis Breier, president at Fairwater Wealth Management in Downers Grove, Ill. “However, when we analyze their portfolio, we come to find out their current allocation is anything but conservative.”
Ultimately, investors who haven’t properly defined their risk tolerance run the risk of losing more than they’re comfortable with. Conversely, investing too conservatively could cause them to miss out on potentially larger returns. Breier’s practice uses a risk analysis tool to help clients identify their risk tolerance while also capturing the level of volatility present in their investment mix. An allocation that properly accounts for investors’ comfort with risk can help build a proper asset base — and allow them to sleep at night.
4. Look Beneath the Surface
Some investors assume they hold a diversified portfolio because they hold an assortment of mutual funds. Without checking the top holdings within each fund, however, many investors could be surprised to discover they’re substantially less diversified than they thought.
“I’ve had multiple cases where clients were in four to five mutual funds that were essentially the same,” said Robert Palidora, a financial consultant with AXA Advisors just outside Philadelphia. “It’s like playing Russian roulette and putting all your money on black.”
Once a proper asset allocation strategy has been established, a portfolio rebalance is an easy fix for investors. “Within certain accounts, you can also add automatic rebalancing to keep the allocation in line,” he added.
5. Ease Up on Company Stock
Many companies offer stock options or other incentives to employees, making it an attractive investment option. Employees should carefully monitor the percentage of employer stock within a portfolio because even seemingly successful companies unexpectedly go bust. Remember Enron?
6. Think Long Term
There’s a mistaken notion that to be successful in the financial markets, one must actively trade stocks, said Robert R. Johnson, president and CEO of The American College of Financial Services in Bryn Mawr, Pa. Many try to determine which stocks or market sectors are going to rise in the near term and then move assets into those areas. Those who think they can identify hot sectors and anticipate trading opportunities are speculators, not investors, Johnson added.
“Market timing is incredibly difficult. Professional investors will admit that they can’t time the market,” he said.
In fact, 86 percent of professional investment managers weren’t able to beat the market in 2014, according to published reports. That doesn’t leave much hope for the amateur investor.
Instead, Johnson suggested a strategy of consistently investing in low-cost diversified index funds over a long time horizon. Those who try to time the market inevitably sell after the market has fallen and buy after a market rise. “It’s the opposite of the old adage, ‘buy low, sell high,’” he said.
7. Get Systematic
Building wealth can be a much simpler process than many believe, said Johnson. A consistent fixed dollar investment done systematically over a long time period can yield dramatic results.
The number one reason investors underperform is because they succumb to emotional triggers like fear or greed, said Johnson. A systematic investment strategy “allows investors to overcome their behavioral biases” so they sidestep the temptation to get greedy after the market has risen or become fearful and prematurely sell investments after the market has fallen, Johnson said.
These seven fixes make it easy to identify potential portfolio breaks and overcome weaknesses before any damage is done.