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When it comes to checking your portfolio, think quality, not quantity.
“For most people quarterly is more than enough, and for some people even that could be too much” says Owen Malcolm, a certified financial planner and managing director at United Capital in Atlanta. “What you want to avoid is making knee-jerk decisions because of one good quarter or one bad quarter.”
No doubt, checking your portfolio too frequently can do more harm than good. That’s because most people hate losing money far more than they love making it—so much so that they will make bad decisions in the name of avoiding future pain. This phenomenon, called loss aversion, was first documented by Daniel Kahneman and Amos Tversky in 1984 and is a major influence on investor behavior.
Better to avoid the emotional roller coaster by scheduling periodic portfolio checks and establishing ground rules for when to make changes and when to leave your portfolio be. One caveat: If you own individual stocks you will probably want to check your portfolio more frequently, within reason.
Start with a broad-brush look at your portfolio and its various components. “At the most basic level you’re looking for outliers and big changes,” says Malcolm. In addition to looking at absolute returns, see how your funds have performed relative to comparable indexes and their peers.
Morningstar and Lipper’s peer rankings show how funds performed over various periods relative to similar funds. Your funds don’t need to be in the top decile, but a sudden drop in relative performance warrants a closer look. Don’t do anything rash. “One of the worst mistakes an investor can make is to sell out of what has done poorly and put money into what has done well,” he adds.
In fact, you shouldn’t expect all of your funds to knock it out of the ballpark. “If they do, something is probably wrong,” says Malcolm. After all, the whole point of diversification is to identify asset classes that complement, not overlap.
How often should you rebalance? Most experts say that once a year, maybe twice, is plenty. “Rebalancing means you have a transaction, and a transaction inherently involves costs,” says Bob Phillips, a chartered financial analyst and managing principal at Spectrum Management Group in Indianapolis, Ind. There are also tax-related expenses, which can be a real drag on returns and a hassle to track.
In a study published by the CFA Institute, researchers found that for most investors, particularly in a taxable account, the best strategy was to rebalance once a year and only if your asset allocation is more than 5% off its mark. In other words, if your target allocation is 60% stocks and 40% bonds, you don’t need to rebalance until you get to 66% stocks and 34% bonds.
One way to keep things in balance without incurring transaction fees and tax headaches is to adjust your contributions. Direct all or most of your new investments to the under-represented securities until you are back where you want to be.
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