Give your portfolio regular checkups

November 8, 1999

Are your investments "on plan"? Or have they gotten dangerously far afield? Here's how to decide.

Give your portfolio regular checkups

Jump to:Choose article section...The dangers of an out-of-whack portfolioThe tricky part: When to restore, and when to changeBe mindful of tax bites and dividendsMy Best Financial Move

Are your investments "on plan"? Or have theygotten dangerously far afield? Here's how to decide.

By Deborah Grandinetti, Senior Associate Editor

Are your investments still aligned with your financial goals? Or hasthe mix shifted so much that your portfolio is at greater peril than youcan afford? What about your goals themselves--have they changed since youfirst chose your investments? If you haven't asked yourself these questionslately, perhaps it's time.

Putting off a portfolio checkup can be disastrous to your financial health,as one plastic surgeon discovered. He had $1.5 million invested in highlyspeculative small-cap stocks. They did quite well for him during most ofthe '90s--until the spring of 1998, when the small-cap market began to tankand his portfolio's value shrank to $350,000.

This spring, with his nest egg still around $350,000, the surgeon soughthelp from New York City financial adviser and Medical Economics columnistLewis J. Altfest. Altfest rebalanced the doctor's portfolio by replacingsome of the small-caps with large-cap, mid-cap, and international stocks.Since then, the portfolio's value has risen 15 percent.

The dangers of an out-of-whack portfolio

Maybe you think the same sort of disaster couldn't happen to you, becauseyou took care not to put too much in one investment class. But if you haven'treviewed your portfolio in a while, don't be so sure you're still safe.

Let's say that five years ago, you settled on a 60-40 split between stocksand bonds. You allocated half of that 60 percent to large-cap growth stocks.They've done extremely well and, as a result, today they represent 75 percentof your portfolio.

Now you've got a much bigger bet riding on one investment category thanyou did at first. If that category falters--and no category does well forever--yourportfolio will take a bigger hit than you might expect.

By selling some high fliers and putting the money into market sectorsthat have lagged, you can get back to the allocation percentages that makesense for you, and assure that you won't be hurt too badly if one categoryfalls out of favor. To re-establish the initial allocation, you must cutback the 75 percent in large-cap stocks to 30 percent. The money taken outof large-cap growth stocks would then be spread among bonds, and mid- andsmall-cap stocks to restore the 60-40 split, suggests Altfest. To furtherdiversify, he says, you could take any earnings from your growth stocksand plow them into bargain-priced value stocks.

"It takes discipline to stick to your original plan," saysMarilyn Bergen, a financial adviser with Capital Management Consulting inPortland, OR. "That's where most do-it-yourself investors have trouble.For instance, they figure: Why buy small-company stocks, which had a terrible1998, when blue chips are doing so well? It doesn't feel right."

The tricky part: When to restore, and when to change

Restoring the former balance isn't always the best option, however. Anallocation you set up 10 years ago may no longer be appropriate, for anynumber of reasons. A revised strategy might be necessary if you're aboutto reach your savings goal, for instance, because the sooner you'll needthe money, the less risky your portfolio should be.

Let's say your 15-year-old will be college-bound, and you've been investingin stocks to build a tuition fund. Lately, your technology stocks have doneparticularly well. But since you now have only two or three years beforethe first tuition payment is due, you'd be wise to sell at least a portionof your stocks--beginning with those volatile technology issues--to lockin the profits, suggests Susan Pevear, a Lexington, MA, investment adviser.Then put the money into more-stable instruments such as money-market fundsor short-term government bonds. This way, you're certain to have it whenyou need it.

You should also reconsider your asset allocation whenever your incomeincreases or decreases, whether through an inheritance, career advancement,retirement, or a change in marital status.

How often should you do a review? That de-pends on the kinds of holdingsyou have, how fast they're rising or falling, and how much you have invested.In general, if your portfolio is worth $250,000 or less, you should re-evaluateit at least once a year. At that time, you should re-examine your goals,see whether your investment strategy still applies, and determine any changesyou need to make.

If you have more than $250,000 invested--especially if you own a dozenor more individual stocks--review your portfolio at least each quarter,Bergen says. Altfest is comfortable with twice a year, assuming most ofyour money is in mutual funds.

If you decide to restore your portfolio's original balance or to changethose allocations, be careful not to base your buy-and-sell decisions onshort-term circumstances. "When there's a meltdown in an emerging market,for instance, events generally move too fast for people to act rationally,so it's better to wait out the correction," says Pran N. Tiku, presidentof Peak Financial Management in Wellesley, MA. The same applies, he says,when the Federal Reserve raises interest rates, as it did in August. "Manytimes, the market corrects temporarily. You don't want to make big changesbased on the news of the day."

Tiku's philosophy saved an internist from losing as much as $20,000 ina few weeks. The doctor wanted to buy into the Russian market. It had alreadydropped substantially, and the internist thought he was catching it at thebottom. But since the $50,000 he wanted to invest would have increased hisportfolio's share in emerging markets beyond 5 percent, Tiku advised againstit. As it turned out, the Russian market continued to fall.

Like the internist, you may want to enlist the help of an adviser youtrust when it's time to review your portfolio. There's no substitute forthe seasoned strategy you can get from someone who has studied the marketfor years--especially if you sometimes need to be saved from your own well-meaningbut misguided impulses.

Be mindful of tax bites and dividends

When you sell winning investments to rebalance your portfolio, you'llincur taxable capital gains. However, you can minimize the taxes.

First, consider whether you can accomplish your goal by selling onlyinvestments in a tax-deferred account, such as a Keogh or a 401(k). If youcan't, sell some losing investments as well as winners, to offset the gains.You could then reinvest the proceeds in a different but similar investment,so that you maintain exposure in the same asset category. For example, insteadof dabbling in a dozen small-company stocks, you could sell the dregs togenerate a tax loss and reinvest the money in a small-cap mutual fund.

Take care not to rebuy the exact investments you sold at a loss, however,even if you expect them to recover soon. If you do so within 30 days afterselling them, the IRS will call it a "wash sale" and deny yourloss deduction.

Another option, if you have the cash available, is to hold on to yourwinners but balance them with investments in other categories that needbeefing up. For instance, if keeping all your favorite blue chips throwsoff the balance between large-caps and small-caps, you might add sharesof slumping small-company stocks that you still have confidence in. Thatway, you'll restore your preferred allocation without generating taxablecapital gains.

Also pay attention to timing if you've decided to part with some winners.Try not to sell them until you've owned them for longer than a year. Thatway, you'll pay the 20 percent tax rate for long-term capital gains, asopposed to your personal income rate, which could be nearly twice as highand applies to investments held for a year or less.

Timing matters when you buy mutual funds, too. Most fund companies distributetheir capital gains and dividends at the end of the year, so wait untilafter this happens before making your initial investment in a taxable account.Otherwise, you'll pay tax on additional income, without seeing any risein your fund's share price.

My Best Financial Move

"When I left a teaching position for private practice, I rolledthe money in my 401(k) retirement plan into a self-directed IRA. My mutualfunds had been lagging the market, and I wanted more control over my investments.

"I can put only $2,000 into the IRA annually. Even so, in thetwo and a half years since I made the switch, my fund has grown from $140,000to $350,000. I've mostly avoided bonds and mutual funds and concentratedon individual stocks. My holdings reflect my love of medicine and computers:Ballard Medical Products, InnerDyne, Northfield Laboratories, Apple Computer,Dell Computer, Go2net, Intel, Microsoft, and the like.

"I realize we've been in a bull market for some time, and thefuture will hold ups and downs. But I have a long-term, buy-and-hold approach,and by investing in good companies, I should do pretty well."

--Charles W. Breaux Jr., MD

Deborah Grandinetti. Give your portfolio regular checkups. Medical Economics 1999;21:79.