Managing your Portfolio

Managing your investments is not about trying to incorporate every good idea that you hear about into your portfolio. Following that path leads to a portfolio that has drifted away from your original objectives and often becomes concentrated in equities.

Managing your investments is about making adjustments that fall within the guidelines that you have established for yourself.

If a stock seems to present an attractive opportunity and your portfolio is already at its maximum equity exposure, then you must decide which of your existing equities should be replaced by this new stock. That decision should be based not only on the potential performance of the new investment but also on its correlation with other investments in the portfolio.

Keep the concept of diversification in mind.

Conversely, if an investment that you hold seems to be performing poorly, consider any changes carefully. For example, investors may be tempted to reduce their exposure to bonds dramatically when equity markets are in a strong uptrend. They begin to chase returns and abandon the concept of diversification and sound portfolio management.

While there can be a strong temptation to abandon an investment plan, if you have laid out a sound framework and honestly assessed your tolerance to risk, stick with your plan. If something still seems wrong, review your plan to ensure that your circumstances and objectives haven’t changed dramatically. If they have, revise your plan before making any dramatic investment decisions.

There will be times when your portfolio will disappoint you and times when it will exceed expectations. It is important that you manage your portfolio in both of these situations.

Common mistakes

Two common mistakes that investors make when managing their finances are ignoring their portfolios and micromanaging their portfolios.

Ignoring your portfolio

When markets are performing poorly there is a natural human tendency to put the entire issue out of our minds.

No one likes bad news but leaving your statements unopened is a bad strategy. Investors who face adversity and make sound decisions in time of crisis are more likely to succeed. It might include a reevaluation of their tolerance to risk, a reallocation among asset classes or changes to specific investments.

Keep the lines of communication with your advisor open. Analyze the situation together and look for solutions rather than looking for someone to blame.

Micromanaging your portfolio

At the other end of the spectrum is the investor who micromanages his portfolio. It can become a case of not seeing the forest for the trees.

These investors agonize over day to day, week to week and month to month fluctuations in portfolio values. They want to act on every new idea they see and become impatient when portfolio performance lags even over short periods of time. Statements are compared every month and a short term drop in value suggests to them there is a flawed investment strategy or an impending crisis.

Micromanaging rarely leads to reducing volatility and will often reduce performance because of the additional costs incurred when making those changes. The results of this approach are reflected in the Dalbar report discussed earlier.

The Compromise

The best compromise is to honestly assess your tolerance to risk and build your portfolio with that as your guideline. You will still experience periods of time where your portfolio falls in value but a well-constructed portfolio should give you the confidence that your investments are well positioned.

That doesn’t mean your portfolio should be put on cruise control.

Conditions are always changing, unexpected risks may arise and unexpected opportunities may present themselves. Sound portfolio management takes those factors into consideration and makes appropriate adjustments within the guidelines you have set for yourself.

Notes: 

  • Mutual funds represent an effective way for small investors to start a diversified portfolio.
  • Tax free savings accounts (TFSAs) provide another valuable tool for Canadians to grow their personal wealth.
  • The type of account most appropriate for your situation will likely change over the course of your life.
  • Taxes can have a significant impact on your efforts to accumulate wealth. Ensure that the accounts and the investments you choose take this into consideration.
  • Your plan should be dynamic rather than static. It should change as your needs and your personal circumstances change.

NEXT: Summary & Conclusion

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