Just as we tend to accumulate more toys, furniture and knick-knacks than they know what do with, many investors have a similar glut of "stuff" in their portfolios. For every single portfolio I see that's whippet-thin—without an excess stock, fund or ETF to spare—I come across 10 more that have 50, 60, or even 100 individual holdings.
Of course, in the scheme of investor problems, over-diversification isn't the worst sin. Having too many holdings won't wreak the same havoc that under-saving will, or overpaying, or performance-chasing. But portfolio sprawl can add to investors' oversight challenges. It can simply be difficult to keep track of the fundamentals of so many holdings, especially if those holdings include individual stocks or actively-managed funds. The investor with too many holdings may have trouble figuring out their asset allocations or knowing when or how to rebalance. Having too many stocks and funds can also compound the headaches for an investor's successors. Widows, widowers and other loved ones may have difficulty untangling the web of the too-acquisitive investor.
Portfolio sprawl can also have negative repercussions for performance. If an investor amasses a lot of holdings, especially multiple diversified equity and bond funds, their performance within each asset class can become very index-like very quickly. But if that same investor is paying active management fees, sales charges or some combination thereof, the portfolio may well underperform a buy-and-hold portfolio consisting of simple index funds with ultralow costs.
In a recent article about New Year portfolio resolutions, I suggested that investors put streamlining their portfolios on their to-do lists for this year. Here are some dos and don'ts to keep in mind.
Do: Collapse Like-Minded Accounts
We're a nation of job-changers; the typical person has been on the job for just six years. Thus, it's no wonder that many investors hold multiple workplace and personal pensions that contain assets accumulated at former positions. Rolling all of these orphan accounts into a pension wrapper can be a great way to clean up the mess in a hurry, giving you just one major account to monitor on an ongoing basis.
Start the process by deciding whether you want to roll your pensions in with your current employer’s pension scheme, or whether you want to roll them into a self-invested personal pension (SIPP) that you can manage yourself. If you choose the latter, decide which fund company or brokerage you'd like to house your SIPP; that firm can then coach you on the logistics of getting everything rolled over into a single account. It’s normally a pretty painless process, thanks to the recipient firm handling most of the paperwork.
Don't: Take It Too Far
Even though combining pension accounts into a plan can be a simple way to reduce the number of moving parts in a portfolio, it's not the right answer in every situation. In particular, workplace pensions and other defined-contribution plans may offer investment types that are unavailable to individual investors. Your workplace pension may also offer ultra-low-cost institutional share classes that you couldn't buy on your own; however, with the advent of ultra-low-cost index products, that's less of a selling point for pension providers than it once was.
Do: Take the Best and Leave the Rest
Holding assets in multiple silos—SIPPs, ISAs and taxable accounts—is all but inevitable for most investors, compounding the potential for portfolio sprawl. And you can multiply that problem times two if you're part of a married couple, with each partner holding several distinct accounts. Many investors manage each of these sub-portfolios as well-diversified portfolios unto themselves, necessitating exposure to UK and international stocks as well as bonds.
However, you can reduce the number of holdings in your portfolio and ensure that each is best of breed by thinking of all of your retirement accounts as a unified whole. That's because it's the total portfolio's asset allocation that matters, not the allocations of the constituent portfolios. For example, if your workplace pension plan has terrific equity index funds but lacks solid bond options, you can load up on equities in this portfolio and compensate by holding more bond funds in your ISA.
Don't: Take Consolidation Too Far
Even as accumulators can get away with the type of streamlining I just discussed, intra-account diversification becomes more valuable if retirement is close at hand. Because you want to retain the flexibility to pull assets from any of your accounts during retirement, you may have good reason to hold both more- and less-liquid asset types within each of your accounts. That way, you can be flexible about which account you go to for withdrawals in a given year during retirement.
Do: Use Morningstar Analyst Ratings as a First Cut
If you have multiple holdings fulfilling the same role within your portfolio and are contemplating some cuts, it's valuable to conduct a head-to-head comparison. One of the quickest ways to do so is to use Morningstar Analyst Ratings—the star rating for stocks and the medallist system (Gold, Silver, and so on) for funds. These ratings are designed to provide a forward-looking assessment of a security's prospects. Of course, you may have good reason to hang on to securities that don't rate well—for example, you may have a very low cost basis in that 2-star stock you're holding in your taxable account, or your Neutral-rated small-cap fund may be the sole small-cap option in your workplace pension. But the ratings provide a sensible starting point in the process.
Don't: Focus Exclusively on Trailing Returns
If you find duplicative holdings and are conducting your own "cage match" of two securities that play in a similar space, be careful not to focus too much on trailing returns. Despite recent volatility, the market has rewarded risk-taking since it began to recover in early 2009. By focusing disproportionately on investments with happy-looking trailing returns—especially over the past three- and five-year periods—investors may inadvertently tilt their portfolios towards higher-risk, higher-volatility investments.
To help avoid that trap, make sure your due diligence encompasses an assessment of each investment's risk profile. Eyeballing returns in the year 2008 is a good first step, to see how your investments weathered the storm and therefore what kind of animal you're dealing with. Morningstar's analyst reports also aim to address the potential risks that accompany each investment. And if you're looking for a data point with the greatest predictive power for fund performance, a fund's expense ratio or ongoing charge is the best way to stack the deck in your favour. You can't go too far wrong by concentrating your holdings in the lowest-cost investments in your choice set.
Do: Employ Broad-Market Index Funds and ETFs
Broad-market index funds and exchange-traded funds can be a great starting—and ending—point for investors aiming to streamline. A single total UK stock market or international index fund, for example, has at least some exposure to companies small and large, value- and growth-oriented. A total UK bond market index fund won't be quite as encompassing—it won't include junk bonds, for example—but it will provide representative exposure to the UK investment-grade bond market. As such, it could reasonably serve as a standalone bond holding for investors who are still in accumulation mode. Even if you also hold actively-managed funds, by anchoring your portfolio in index funds, you'll be able to get away with fewer holdings and bring your portfolio's average costs down.
Don't: Hold Individual Stocks If You're Just Not That into It
Many investors use funds or exchange-traded funds for the bulk of their portfolios while also maintaining a smaller basket of stocks on the side. If that describes your set-up, reflect on your past behaviour and performance as a stock investor. If you have tended to do your homework on your companies and have generated strong performance with this part of your portfolio, that may argue for making individual stock holdings an even larger part of your portfolio than they already are. But if you have amassed a portfolio of individual equities more haphazardly—and monitored them not at all—it’s a good time to ask yourself what those small positions are actually doing for you. If your total position is fairly small, it's adding to the clutter in your portfolio but doesn't have the potential to dramatically alter your bottom line, for better or for worse.
