Why investors need to spring clean their portfolio

After tax season, use the information to ensure your investments are in order.

  • By Jeff Brown,
  • U.S. News & World Report
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With the arrival of warmer weather and daffodils, people get outside to tidy up. And while they're in the mood, it can be a good time to trim the shrubs and shift the bulbs in the investment portfolio, too.

January is the time many think of financial tidying like rebalancing the portfolio, a tradition rooted in the days when annual statements from fund and brokerage companies make the task easier. But investors nowadays can check performance and asset allocation anytime with a few clicks of the mouse, so cleaning up is easy spring, summer or fall, too.

"Triggers for rebalancing should include a variety of factors such as being off target as well as personal life changes and financial goal changes," says Jennifer Wironen Corso, an advisor at Edward Jones in Westminster, Massachusetts.

The tax return filed in April can provide insight into taxes on investment income, year-end capital gains distributions and capital gains – factors that can spur changes.

So, if you didn't rebalance your holdings in January, there's no reason to wait until next year. In fact, waiting too long can be damaging if a mismatch between stocks and bonds will stunt your returns or heighten your risk.

A proper spring cleaning should involve a top to bottom look at financial matters. Here are a few key things to keep in mind:

  • Portfolio rebalancing.
  • Fees.
  • Taxes.
  • Budgeting.

Portfolio rebalancing

This is the landscaping of the process, involving the mix of stocks, bonds, cash and subsets within each category. Many experts point to research showing that the mix is the most important factor in performance over time. Too much in stocks makes a portfolio too volatile and could produce deep losses if the market tumbles. Too much in an individual stock makes that danger even worse. Too much in short-term bonds or cash can reduce growth.

"The idea is to create a reliable process that allows you to maintain the risk profile of the portfolio you originally intended when you set up your initial allocation," says Nicole Tanenbaum, chief investment strategist at Chequers Financial Management in San Francisco.

So, with professional help or one of the many portfolio management tools that can be found by searching for "asset allocation calculators," investors should settle on a mix that suits their age, goals and willingness to take risk. Then assets should be moved from time to time to keep to those allocations.

If stocks are meant to be 50% of the portfolio and have grown to 60%, sell some stocks and buy bonds to get back to the plan.

But don't overdo it.

"Reviewing a portfolio's allocation too often or constantly rebalancing based on small market moves can rack up costly transaction fees and won't meaningfully affect the overall outcome of the portfolio," Tanenbaum says. "Additionally, obsessively monitoring the daily ups-and-downs of the markets can lead to illogical, emotionally-fueled buy and sell decisions and cause even the most rational long-term investor to veer off course."

Kurt Rossi, CEO of Independent Wealth Management in Wall, New Jersey, says one option is to rebalance once or twice a year, or when allocations are off by 5%.

"Many analysts have noted the advantages of a combination of the two approaches," he says.

So long as the entire portfolio has the desired asset allocation, it's not necessary for each account to match the overall plan, so the changes can be done in tax-favored plans like an individual retirement account and 401(k) to avoid a tax bill.

"Since you do not have to worry about capital gains taxes in a retirement account, it may make sense to begin there," Rossi says.

"Thinking about your accounts as one large portfolio rather than managing each account individually allows you to maximize your after-tax returns," says Kieran Osborne, chief investment officer at Mission Wealth in Santa Barbara, California.

Fees

Another matter to watch out for is excess fees which choke the portfolio like weeds choke a lawn. These include trading commissions, account maintenance fees and markups for bonds. The easiest ways to minimize fees is to buy funds directly from the fund company rather than through a full-service broker and to use index funds rather than managed funds.

Many index funds and exchange-traded funds charge less than 0.2% a year, compared to more than 1% or 2% for many managed funds. And there are more index products all the time, so if you like everything about your managed fund except the fees, you may well find an indexing alternative that can do just as well and charge less.

Taxes

To reduce annual tax bills, investors can shift to "tax efficient" funds. This includes index funds, which don't generate taxable year-end distributions because they hold stocks and bonds for the long term, plus "tax managed" funds that use various techniques for minimizing taxes, like selling shares bought at the highest cost basis.

"Someone with a high marginal tax rate may consider swapping taxable bonds for municipal bonds, or perhaps holding sources of taxable incomein tax-free or tax=deferred accounts like Roth of traditional IRAs," says Matt Miller, principal at Upleft Financial in Port Townsend, Washington.

"Tax inefficient mutual funds can generate short-term capital gains which are classified as ordinary dividends," Miller says. "If the dividend income is not needed for cash flow, an investor may consider a more tax efficient investment portfolio or locating the tax inefficient fund in a retirement account."

Budgeting

The best way to build an investment portfolio is to put more money in, and that can be achieved by trimming other expenses. Among the large ones: can you cut your mortgage payments by refinancing? Could you get by on one car instead of two? Could a low-cost term life policy serve you better than a pricy permanent policy?

The budget and investing strategy may need to be modified from time to time as the investor's situation changes, Corso says. Changes, for instance could be in order if the family gets larger, grown children leave home, income rises or falls, etc.

Smaller expenses can add up, too, so a thorough spring cleaning would look at repeat payments like music subscriptions, cellular data plans and premium cable channels. One budgeting strategy is to carry paper and pen and write down every expenditure for a month. Those fancy coffees and muffins can really add up over time.

"It is always a good idea to assess the budget annually in order to determine appropriate investment strategies," Corso says.

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