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Annual portfolio review pointers your adviser ought to embrace

 
Fisher Investments UK Contributor
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End of year investment portfolio review (Source: Adobe)

With the holiday season drawing near, the end of 2017 is close at hand. To many investors, this is a sign that it’s time to review portfolios and potentially rejig for the new year. From a professional’s perspective, this is welcome.

It is refreshing to have investors engaged in discussing portfolio returns. But to make the most of this time, here are a few pointers that should help guide your thinking. A discussion in keeping with these factors should be welcome to your adviser—if it isn’t, you might think twice about their services.

Assess asset allocation

Most year-end reviews fixate on performance. That is potentially an aspect to review, as we’ll cover, but your review shouldn’t start and stop at a backward-looking performance comparison. In our view, the place to start is reviewing whether your overall asset allocation—the mix of equities, fixed interest, cash and/or other securities—is aligned with your investment goals.

For folks needing long-term growth to reach their goals or even just outpace inflation, holding some equities is likely necessary. Yet many, perhaps still stung by 2008 or fearing Brexit will trigger negativity, hold far too little in stocks relative to their goals and needs. With abundant speculation about where interest rates are headed, many investors increasingly fear fixed interest, too.

Regardless of the reason, holding large amounts of cash or very low-returning securities is a potentially large opportunity cost that diminishes growth. While holding an emergency fund or money targeted for a near-term purchase in cash is smart, don’t get carried away. If you find you’re holding more cash than necessary, investing it may be a smart long-term move. If you need growth and have a huge dose of ultra-low yielding fixed interest securities, focus your review here: Your allocation may need serious change to align it with your goals and needs.

Diversify risk

Moreover, your holdings review could reveal the need for greater diversification. Investing exclusively in one geography or sector may increase risk and reduce opportunity. Even the biggest country in the world (the US, at 59% of world market capitalisation) is still just a portion of a much bigger whole.[i] The UK, whilst larger than most countries, is only 6.5 per cent of the world.[ii] Spreading your assets across multiple sectors and geographies may be optimal, as equities in the same sector usually act similarly.

In our experience, a globally diversified portfolio optimally balances opportunity and risk management, using the market’s sector and country weightings as a construction guide. You could use the MSCI World Index to gauge this. This doesn’t mean matching the market’s weightings exactly. If you believe certain categories will do better or worse, it makes sense to adjust your portfolio accordingly. Whatever your belief, however, you could always be wrong, so having broad exposure mitigates risk.

Diversify, diversify, diversify

Continuing the diversification theme, we believe no single company should exceed 5 per cent of your portfolio’s value. The higher the percentage, the more damage it could cause should things go awry. Yes, this does mean you wouldn’t benefit hugely if a single company you own surges. But in our view investing isn’t about that—it’s a long journey, not a fast road to riches. Besides, in our experience, far more investors shoot for such lofty returns and miss than those who hit. Keep that in mind as you review your holdings.

This same logic applies doubly if you work for the company you own a large stake in. Owning a huge slice not only violates basic diversification, but it adds another risk: If the company suddenly hits dire straits, both your current income and your investments are connected to it. Here’s another permutation: We often see fixed interest investors holding huge individual positions in corporate debt. Diversity matters within fixed interest, too. Don’t fool yourself into thinking you needn’t diversify because fixed interest is “safe.”

Holding a diversified portfolio isn’t easy—it can require you to sell “winners” and hold or buy “laggards,” a decision at odds with human nature. “Order preference,” a behavioural error, makes investors want to see nothing but green arrows when we log in to our accounts. Yet all assets moving similarly shows a lack of diversity—a big risk.

On return calculations

With diversity and allocation reviewed and assessed, let’s cover returns. First, a helpful reminder: If you contribute to or withdraw from your portfolio, your return calculations must account for these actions. Obviously, you can’t just compare the beginning and ending values. You must use geometrically linked, time-weighted returns, which is as jargon-packed a phrase as we’ll ever write. It basically means: Each contribution and withdrawal has a performance impact you must remove. If you are making comparisons, ask your adviser to provide a correct calculation first. They should be able to do so easily. In addition, make sure you include dividends and interest.

The calendar’s arbitrariness

When you start reviewing the previous year’s numbers, don’t assume a single year is all that telling. Most investors have much more than one year to plan for, and such short time periods likely don’t tell you much about your strategy or portfolio. As for calendar cutoffs, no bull market in history began on 1 January and ended on 31 December. There is nothing special about the calendar year—cycles, context and circumstances matter more. We’d humbly suggest a longer timeframe is much more telling.

An apples-to-apples comparison

Whatever timeframe you choose, don’t forget to use an appropriate measuring stick (or benchmark). This will depend on your asset allocation and the makeup of those holdings. If your portfolio is 70 per cent equities and 30% fixed interest, it is incorrect to measure returns against a 100 per cent equity index. You’ll need a blend.

Even within each asset class, make sure you are comparing like to like. Would you compare the return of an exclusively British stock portfolio to a Venezuelan index? Ridiculous, right? The same error—inappropriate comparison—underlies equating all-UK gauges to global portfolios. If you’re globally diversified and own all equities, you ought to compare to a global index. If you are all UK, then a UK index is appropriate. (Though, as noted earlier, we think global diversification is superior.)

In this same vein, comparing to things like your neighbour’s portfolio is a mistake. Even if you’re both the same age, grew up in the same neighbourhood and root for the same football team, she may have very different investment needs and goals, so her asset allocation may not resemble yours. Moreover, you don’t know how she is managing for risk: She might own six companies in concentrated positions with no risk controls—an unwise strategy.

A final factor

Finally, an important-yet-overlooked aspect of the annual review should be an appraisal of what you got right and wrong. If, for example, you feared Brexit, Trump, euroscepticism or others spelled doom in 2017, don’t forget that. Embrace it. Human nature makes investors want to shun errors, but they are great tools to learn from. Then, when similar fears crop up, you have valuable perspective to put them in before assessing the particulars.

If you follow this general layout, we think your annual portfolio review can be a rewarding experience for you, building confidence that your finances are on track—and helping you catch potential errors before they compound. And again, if your adviser shies away from answering questions in this vein, well, consider a change. All this is standard, basic logic any professional should embrace.

Investing in equity markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world equity markets and international currency exchange rates.

Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited Headquarters: 2nd Floor, 6-10 Whitfield Street, London, W1T 2RE, United Kingdom. Fisher Investments Europe Limited’s parent company, Fisher Asset Management, LLC, trading under the name Fisher Investments, is established in the USA and regulated by the US Securities and Exchange Commission. Investment management services are provided by Fisher Investments.

This document constitutes the general views of Fisher Investments UK and Fisher Investments, and should not be regarded as personalised investment or tax advice or as a representation of their performance or that of their clients. No assurances are made that they will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts may be, as accurate as any contained herein.

[i] Source: FactSet, as of 14/11/2017.

[ii] Ibid.

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