Buy and Hold, But Review

On 04/29/2011, in Investment Strategies, by Jordan Wilson

In general, I like the buy and hold investment strategy.

Assuming, that is, you passively invest in a well-diversified, low-cost portfolio.

But I also think that a buy and hold strategy needs a little tweaking.

One such tweak involves the need for periodic portfolio reviews.

Today we will look at frequency of reviews.  

There is no hard and fast rule as to the frequency of portfolio evaluations.

The number of reviews you conduct, if any, will reflect a few factors. As these differ between investors and their portfolios, so too will the periodicity of portfolio assessments.

Portfolio Risk Level

The timing of evaluations should be connected primarily to the risk of the portfolio.

If you have a relatively low risk, well-diversified portfolio of mutual and exchange traded funds, annual reviews may be adequate.

As the portfolio volatility (i.e., standard deviation) rises, you may want to increase the frequency of your evaluations. Maybe semi-annual reviews for portfolios with moderate risk levels. Perhaps quarterly reviews for portfolios with high standard deviations.

For portfolios that are not well-diversified, quarterly to semi-annual assessments are prudent. This holds true even for lower risk portfolios. And the less diversification, the greater the need for more frequent reviews (the exception being for single investments in extremely low risk assets such as Treasury bills, term deposits, etc.).

The logic of increased frequency for high risk or weakly diversified portfolios is that external factors can have significant and rapid impact on highly volatile and/or non-diversified investments.

For example, perhaps you have a concentration of investments in the Middle East. Given all the political turmoil there at the moment, you would want to monitor your assets very closely. If you wait a year to do an evaluation, you may find that the current governments have radically changed and that new business rules are in place that affect you investments.

General Market Volatility

Over time, certain events can cause excessive volatility in the markets. Most of these are systematic risk factors.

On the down side, events may include inflation, high unemployment, political turmoil, stock market crashes, wars, natural disasters, and so on. On the positive side, there may be long bull markets due to the opposite events, such as low unemployment, low inflation, peace, etc.

The greater the general market volatility, the greater the focus should be on your portfolio.

In part because strong systematic risk events can have wide ranging impact on one’s investments. Unlike nonsystematic risk factors that you can minimize through proper diversification, it is more difficult to protect against systematic factors.

And in part because your well-diversified portfolio of passively managed index funds should reflect the market itself. As general market volatility increases, so too does your own portfolio. Therefore, you should increase your amount of reviews accordingly.

Investor Personality

Periodicity of portfolio reviews will also reflect your personality and investor risk profile.

Not that it should, but an individual’s personality plays a role in how they manage their assets.

If you are a detail oriented person, you will likely be more comfortable reviewing your assets monthly, or even weekly. No doubt using spreadsheets or investment software to drill down into the numbers. If you are quite relaxed about life, then even an annual check-up scribbled on the back of a napkin may feel onerous.

The same applies to one’s investor risk profile. Low risk investors will normally want to monitor their portfolios more closely than a high risk investor. The opposite of what should be done, but it ties into their personality in many cases.

Given the importance in generating adequate wealth for a comfortable retirement, I suggest you put aside any personality traits that lead you to defer reviews. Put in a little time now on performing proper evaluations and you will reap the benefits down the road.

And Me?

I like to review portfolios quarterly or semi-annually as standard monitoring practice.

That is because I tend towards a portfolio with a moderate to slightly high risk level. I also include individual assets in my portfolio to complement my core fund holdings. So I want to keep a closer watch on my portfolio than perhaps someone with nothing but index funds spread across multiple asset classes and subclasses.

I also like to conduct an analysis whenever a systematic risk factor is either anticipated or unexpectedly arises.

Despite what the U.S. Fed would have us believe, we have seen the coming inflation for a while now. This is an anticipated risk. Once its approach has been identified and confirmed, I like to consider its impact on my portfolio.

The recent earthquakes in Japan, and subsequent problems, are examples of unexpected systematic risks. When something like this suddenly occurs, I will review its current and potential impact on my investments.

If I wait until my standard quarterly or semi-annual portfolio review before assessing the potential impact of either an anticipated or unexpected event, it will likely be too late.

So anytime there is a material event take place – that is, something that will affect my decision-making – I like to evaluate it against my assets.

Now you know that you should review your portfolio on a periodic basis.

Next we will discuss how to conduct those reviews.

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