Your funds should work as hard as you do.
At the end of each quarter I like to evaluate the performance of each of my funds.
I don’t necessarily make an immediate change but I will record my thoughts and persistent trends will result in action.
Here is how I approach my review:
Step 1: Performance Check
I will start by evaluating the overall performance of my full portfolio.
So I do not want to be overly myopic if an individual fund class is out of favor when there is a greater purpose for that fund in my portfolio.
This is where comparisons to benchmarks comes into play. Morningstar ® provides a nice overview of appropriate benchmarks by asset type/investment objective.
I will align the funds to their benchmark and focus on those that are under-performing. The base question is whether that is a recent or persistent trend.
If just near-term under-performance I will quickly review the top holdings to understand the specific driver.
Often if an asset has under-performed near term, and the manager has a contrarian bent, that fund may be due for a rebound. Certainly historic performance will be my guide here.
In my last 3 quarterly reviews, I have only eliminated 2 funds, and have added 3. I am very careful in optimizing the number of different funds in my account.
Each time I add a fund, I need to ensure it makes the portfolio incrementally better (more diversified, better return/risk)
Step 2: Fee Check
This should be a primary consideration when buying a fund, so we should not be finding much here.
Sometimes funds will make distribution changes and that will affect the marketing fees (12b-1) or they will change management companies, which again can change fee structure.
401k is the area where I see the most movement. Companies will annually shop this business and may make intention or unintentional decisions that drive up costs.
The employer may have a larger banking relationship with a company that offers 401k services and that may drive a change.
Make sure you are evaluating the options available at the new company and setting both your current portfolio and future allocations in a way where you are achieving your diversification objectives along with minimizing fees.
If you are paying more than 1% of fees, it is time to dig in and check alternatives.
Same rule applies beyond the 401k, if you are paying more than 1% for actively managed fund, start to shop.
If you are paying more than .25% for a passively indexed funds evaluate your alternatives.
Step 3: Diversification Check
As assets come in and out of favor, you will start to see imbalance in your portfolio.
The below table shows equity performance by country. The take-away here is that the top/bottom performers change every year without pattern. Diversification is required.
Diversify Across Assets
Ray Dalio does a tremendous job explaining the benefits of carrying inversely correlated asset classes.
In fact, he refers to this as the holy grail of investing (quick video explanation if interested).
Diversifying across countries is good but leaves equity risk. Having a fixed income allocation has historically been a nice off-set to equity risk.
Adding precious metals (Gold, Silver) helps off-set the risk of Inflation that is the cryptonite of fixed income, and so on.
It is possible to create a portfolio that is optimally balance based in risk premium, which we will cover in detail in another article.
However, this article is about managing the divergence from your desired allocation.
I will recalculate my exposure to my asset calls, and anytime that I’m more than 5% (gross) away from desired distribution, I will sell/buy to rebalance.
Doing this once per quarter has been found to be a nice balance between minimizing transaction costs (cost to trade) and performance.
Check performance (relative to benchmarks), check fees (with 1% rule in mind), and check allocations to keep yourself safe.
Having a set routine will allow you to get comfortable with the process, and having a set frequency will help you optimize your return to risk for your overall portfolio.
Last updated on: