5 Questions To Ask Before You Retool Your Portfolio For 2014

This article was written with Jim Cahn, the Chief Investment Officer at Wealth Enhancement Group. It was part of a series of articles developed under an agreement with Forbes to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.

If you’re wondering if you should make some changes in your investment portfolio for 2014 to react to changes in the market, you’re going about it the wrong way. This may be somewhat heretical coming from an investment advisor, but in reality the portfolio should be all about you, not the market.

What’s going on in the market is secondary. Here are the five questions you need to ask yourself before you make any changes in your investments or allocations.

1. Have my values-based investment objectives changed? A lot of investors think – and advisors talk — in terms of financial goals. The problem with goals in isolation is that they can conflict. For instance “I want to retire early and comfortably” and “I want to be able to take care of my entire family, parents’ care and children’s needs.”

Depending on your financial reality, you may have to prioritize one over the other and, when you do, your investments might change accordingly. It’s unlikely that your core values have changed, although it is possible.

On the personal side, perhaps you have begun or are facing a divorce. In such a circumstance, you would want to rethink risk as most people in this situation think about moving to wealth preservation during this kind of transition.

2. Have my circumstances changed vis a vis risk? This could be something that has happened in your personal life or it could be some kind of shift that has occurred in your portfolio. For instance, if this year your bonus was paid in a large amount of restricted stock, it’s possible you now have a larger exposure to equities than you started the year with. Similarly, you might have inherited investments that have significantly changed your portfolio mix.

In a different scenario, if you’ve hit a “milestone” age, many financial advisors will suggest reducing your equity risk. That’s not the right answer for everyone.

I personally believe in the risk-allocation approach. The concepts were pioneered further back in academics in the early ’90s by Eugene Fama at the University of Chicago and Ken French at Dartmouth. And then they’ve been updated by John Cochrane at the University of Chicago. These ideas started to be embraced by institutional investors in the early 2000s.

3. Has my time horizon changed? Various things can occur to change your time horizon such as facing a serious illness or being forcibly retired. Perhaps unexpectedly, you’ve been lured out of retirement. Maybe all your children have decided against entering the working world upon graduation and plan on enrolling in medical school instead.

When are you going to need money and how much are you going to need? Asset allocation, especially for retirees and pre-retirees, involves what’s called asset-liability matching. In other words matching your assets to your short-, intermediate-, and long-term expenses.

If any significant changes have occurred since you made your time horizon assumptions, then you will want to reflect those in your portfolio.

4. Have any investments or allocations I made changed especially in regards to increased volatility?

If you’ve put money in investments, it’s important to make sure the investments are still delivering what you expect.

Also, due to investment performance, the mix in your investments might have changed. For instance, if you had started 2013 with a 60/40 mix of US equities/US bonds, your mix might have changed.

In regards to volatility, this is where what’s going on in the market – and what you expect the market to do in the future – may dictate changes in your portfolio. For instance in the above case, would you really want to sell out of stocks and reinvest in bonds?

If you believe changes are continuing in the fixed income markets then it’s time to review the fixed income section of your portfolio with a goal of ensuring that size and weight is in line with your expectations for total return.

Contrary to headlines, success in this sector is not all about interest rates, but hinges on variables such as sector allocation, credit quality, durability and whether the holdings are weighted.

We are seeing some strategic income clients changing their portfolios so they aren’t carrying any single bond holding with an effective duration over five years as the risk of income rate volatility doesn’t match up with the reward of higher coupons.

5. Have I used erroneous benchmarks to judge the success of my portfolio? The objective is to catch mistakes and correct course with the ultimate goal of improving results within acceptable risk and other success measures such as cash flow needs and tax considerations.

Hands down, the worst way to judge progress is looking at the bottom of a statement to see whether you are ahead or not for the period. This does not put things in a meaningful context and this lack of objectivity is one reason why retail investors tend to sell at market bottoms and miss out on market rebounds.

However you benchmark, it’s better to judge performance based on returns compared to risk and whether investment objectives are met.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. No strategy assures success or protects against loss. Stock investing involves risk including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Wealth Enhancement Advisory Services, a registered investment advisor. Wealth Enhancement Group and Wealth Enhancement Advisory Services are separate entities from LPL Financial.

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