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Three-Point Portfolio Review August 18, 2010
Three aspects that you should look at for an effective review of your investment portfolio.
Author : FSM Content Team


Untitled Document

 

After having carefully and regularly saved money over years, you decide to evaluate your monetary status and decide to become an investor. You study the basics of sensible investing and select assets according to your financial goals, your stage in life and your risk appetite – you finally have your investment portfolio. Great! But it doesn’t stop at that.

Ongoing changes in the market and the economy have an impact on how your investments perform. Some promising investments may not be able to live up to expectations. Inflation may go up (as it has!) making some of your conservative investments loss making propositions. Changes in your own life and financial circumstances may also make the current portfolio redundant. All this implies that portfolios need to be reviewed regularly to ensure that they serve the purpose within the time frame you have in mind.

Reviewing portfolios, though, is a complex task. A fair amount of study has gone into how our emotions can get in the way of making timely and sensible decisions about changes to our portfolio. In this article, we suggest a three-pronged approach to reviewing your portfolio that should help make the process more structured.

When to Review?

There are varying opinions on how frequently one should review a portfolio. Reviewing too often may not allow medium to long-term strategies to play out. Reviewing after very long intervals may cause the portfolio’s performance to go off on a tangent to what you originally had in mind.

A thumb rule recommended by some experts is that the more volatile your investments, the more frequently you need to review. For the average retail investor’s portfolio comprising largely of debt mutual funds, bank deposits, gold and probably some blue chip equity, an annual review should be fine. In case your portfolio comprises more volatile investments, you may want to track those more frequently. Also, as the following sections suggest, define triggers that help you understand when it is time to act on your portfolio, or seek help for the same.

What to Review: The Three Point Check

It’s time for the review! To help you perform this exercise with accuracy, you should have the following details at hand:

  • a consolidated snapshot of your portfolio, with investments listed according to asset class
  • purchase price and initial investment for each investment
  • current market value of each investment
  • profit/loss on each investment
  • original and current percentage of investment in each asset

 

1. Asset Allocation

When you create your portfolio, ideally, you would have a specific asset allocation based on which you invest in equity and debt-oriented products [refer to Fundersupermart.com’s Recommended Portfolios for a demonstration of asset allocation across different risk appetites]. For example, you may have decided on an aggressive asset allocation of 75% in equity and 25% in debt. As time passes and the investments grow at different rates, the asset ratio becomes significantly different from the original.

 

Year 1

Year 2

Year 3

 

Amount

% of Portfolio

Growth

Amount

% of Portfolio

Growth

Amount

% of Portfolio

Equity

225000

75

15%

258750

76.16

12%

289800

76.82

Debt

  75000

25

8%

  81000

23.84

8%

  87480

23.18

Total

300000

100

 

339750

100

 

377280

 

We see that in a year’s time, the equity assets have grown to more than 76% of the portfolio, whereas debt has reduced to a little less than 24%. It’s important to note that with increase in the equity component, the risk of the portfolio has also increased. Over longer periods of time, the portfolio asset allocation changes to a “higher risk, higher return” allocation than was originally intended. Therefore, it is important to keep track of the current asset allocation in your portfolio to ensure that your investments are not at higher risk than you think.

Review Trigger: Experts suggest that you should set a limit up to which the asset allocation will be allowed to deviate. If the asset allocation shifts by more than the set limit, rebalancing should be initiated to bring the portfolio back to the original allocation. Rebalancing means selling the excess portion of the larger component (in our example, equity) and investing it in the smaller component (debt). This is a disciplined approach that takes away the need or temptation to time the market, and prevents you from assuming higher risk than you can handle. A deviation limit of 10% in our earlier example means that you will initiate rebalancing when equity becomes 82.5% of the portfolio. This limit should be decided keeping in mind how volatile your investments are and how tightly you would like to control the risk.
FSM Tool Tip: Investors on Fundsupermart.com can view their updated asset allocation graph as part of the View Holdings module.

2. Portfolio Returns

It is important to realize that the “profit” or “loss” indicated on your portfolio snapshot is notional – on paper. Depending on how markets continue to behave, the portfolio can make more profits or lose some of these gains. Emotions usually prevent us from selling a profitable investment – we expect or hope to make more profit. Similarly, we often refuse to sell a loss making investment hoping that the prices will improve, helping it recover. This emotional behavior often leads us to lose profits or worsen the losses that we see on paper.

One way to help you systematically consolidate profits or plug losses is to set upper and lower thresholds for portfolio returns. Example: Suppose you set a portfolio profit threshold of 15%, and a loss threshold of -10%. This means, if the portfolio is high by 15% you go ahead and “book profits”; or, if the portfolio has fallen by 10%, you need to sell the loss making units. However, whether you should book complete or partial profits can vary based on the research recommendations for the profit making investment. Similarly, there are various strategies to help gradually liquidate loss making investments to help the portfolio recoup. The important thing is to act in time.

FSM Tool Tip: Fundsupermart.com allows investors to set alerts for ceiling and floor prices for the funds. When either the ceiling price (upper threshold) or floor price (lower threshold) is hit, an email notification is sent to the investor.

 

3. Lifecycle or Lifestyle Changes

There can be changes in your life which affect your investment goals. The following are some cases where you need to revise your portfolio to suit your changed circumstances.

  1. Change in life stage: Based on the stage of your life, your capacity to save, financial obligations and your risk appetite change. All of this needs to be reflected in your portfolio’s asset allocation as well as the individual investments that you select. One common example of this is when you reach retirement. The asset allocation of your portfolio becomes income generating or extremely debt-heavy. So, the focus shifts on products that can generate fixed and regular income that you can use for expenses.Therefore, at any instance of a life stage change – getting married, having a child, retiring, ensure that you review and revise your portfolio accordingly.
  2. Change in lifestyle: Certain changes in life can impact the amount of disposable income available for investment; for example, a promotion, or one of the partners deciding to stay at home to manage the children. At this time it becomes important to review your investment portfolio from the following aspects:
    1. Size of Portfolio: If there is an increase in disposable income, consider increasing your savings amount.
    2. Fixed commitments: Review whether you can continue to meet fixed commitments made in case of a reduction in disposable income. You could also look at changing the frequency of the systematic investments if that helps.
    3. Income/Growth Focus: Review whether the investments should be in growth mode – where profits/interest earned are reinvested directly, or whether you would need them to be in income mode, where the profits/interest are paid out to you on a regular basis.

Conclusion

Wealth creation is a complex task that needs dedication and discipline. Timely review and revision of your portfolio is critical for your investments to bear meaningful results. Equally important are objective financial decisions to protect you from losing whatever benefits your investments may have made. This article aims at helping you develop a structured approach towards this important task. Do ensure that you set aside time to study how your money is faring!

 


Disclaimer: iFAST and/or its content and research team’s licensed representatives may own or have positions in the mutual funds of any of the Asset Management Company mentioned or referred to in the article, and may from time to time add or dispose of, or be materially interested in any such. This article is not to be construed as an offer or solicitation for the subscription, purchase or sale of any mutual fund. No investment decision should be taken without first viewing a mutual fund's scheme information document including statement of additional information. Any advice herein is made on a general basis and does not take into account the specific investment objectives of the specific person or group of persons. Investors should seek for professional investment, tax, and legal advice before making an investment or any other decision. Past performance and any forecast is not necessarily indicative of the future or likely performance of the mutual fund. The value of mutual funds and the income from them may fall as well as rise. Opinions expressed herein are subject to change without notice. Please read our disclaimer on the website.Please read our disclaimer in the website.


 


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