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Keys to Portfolio Reviews

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What are the keys to a successful portfolio review?

Depending on your investment skills and experience, you can assess a multitude of factors. But for most investors, there are some basics that should always be reviewed.

We have covered them in previous posts, but I shall provide a quick summary here. 

Pre-Determined Benchmarks

You should always create benchmarks [4] against which you will compare your portfolio composition and results.

Determine relevant benchmarks – yes, you can and should use multiple benchmarks – prior to actually building your portfolio. This will keep you honest when performing your actual analysis.

It is too easy to find a benchmark after the fact that fits your actual portfolio. But it is important to ensure that you own a portfolio that meets for investment objectives and plans.

As such, benchmarks should be based on your Investment Policy Statement [5] (IPS) and target asset allocations contained therein.

Benchmarks can relate to many different areas. They can be arbitrary numbers [6], relevant publicly available indices [7], peer group [8] data, and your intended target allocation [9]. They can also be combinations of these items.


Performance is what drives wealth accumulation. So you want to make sure your portfolio is doing well relative to its benchmarks.

Performance is what you put in your pocket at the end of the day.

Performance may be annualized or cover the holding period [10]. A 100% return may sound great. But if it takes place over a 20 year holding period, the annual return may not be as nice as it appears.

Understand what portion of performance is due to investment income (interest, dividends, premiums received on options, etc.), realized capital gains, and unrealized capital gains [11].

All are important in your analysis.

Keep in mind that different types of investment returns may be taxed at different rates. In Canada, interest income, dividends, and capital gains are all taxed differently. Always factor in your after-tax returns when analyzing performance.

Never forget that any unrealized gain is not actual cash until the asset is sold. Many investors get ahead of themselves and start spending their profits before they realize them.

This was a big factor in the U.S. real estate downturn. Many homeowners received home equity loans or higher mortgages based on inflated property values. Then found themselves underwater (negative equity) when property values fell.

As the old saying goes, do not count your chickens before they hatch.

Do not forget about costs. Expenses paid to others do not accrue to your capital growth. Gross performance may be interesting, but always focus on net results [11].

And always factor in inflation rates [12]. A 100% return may sound great, but not so much if you are living in a period of hyper-inflation.

And, as we saw in an earlier post, always know what data is being presented [13]. Massaged financial information can lead you to incorrect decisions.

Portfolio Composition

Another apples to apples comparison, especially as relates to portfolio risk.

You want your actual portfolio to reflect he composition of the benchmark, where the benchmark is an index, peer group member or average, or target allocation.

Reflect, not necessarily exactly mirror. Unless you are investing in the index itself.

The reason you want to reflect the benchmark is that you want a portfolio with a similar expected return and risk level as the benchmark.

If you use a risk-free rate (i.e., Treasury bills) as a benchmark for a portfolio made up of shares in unlisted small companies, the comparison becomes irrelevant. That is because you are trying to compare a riskless benchmark against a high risk portfolio. Any comparative data will make no sense.

Asset Allocation

You want your portfolio composition to reflect the chosen benchmarks.

You also want your portfolio’s asset allocation [14] to reflect your target asset allocation as determined in your IPS. As your IPS will be unique to you as an investor, so too will your target asset allocation be unique [15].

And your chosen benchmarks should also reflect your target asset allocation.

If you have a simple target asset allocation of 70% U.S. equities and 30% U.S. denominated bonds, both your benchmark and actual portfolio should reflect this. Perhaps your selected benchmarks should be the Standard & Poor’s 500 for equities and the Barclays Capital Aggregate Bond Index for the bonds. Weighted 70% and 30% respectively.

Material Variance

A material event is one that triggers action on your part.

For example, perhaps you are considering buying a car. Color, interior design, stereo system, horse power, etc., may all play a part in your decision making. They will have a cumulative effect on your choice. But individually, the car’s color or its stereo system probably will not be a deal breaker.

Instead, a sale price, low interest financing, warranty, consumer satisfaction surveys, etc., may play more important roles in your decision. If your potential vehicle is considered a lemon, you may decide to choose a different make. Or if you can get excellent financing terms, you may be swayed in your decision. Any one factor can make or break the purchase decision.

These latter factors are material events. The key points that affect decision making.

You need to identify the make or break points in your portfolio analysis. And these points are largely driven by who you are as an investor. Your risk tolerance, investment objectives, constraints, etc. Your investor profile.

These will obviously differ from individual to individual.

For example, some risk averse investors may not be comfortable with any negative portfolio returns. Others may accept short-term or minor losses, say no more than 10% of invested capital. And others may accept losses of 25%, 50%, or more before taking remedial measures.

While you want to ensure that your portfolio does not underperform, it can be a tricky process. It is a fine line between fine tuning a portfolio and in either waiting too long to make changes or adjusting too often.

I will offer some thoughts on how and when to rebalance a portfolio next week.