5 Common Portfolio Pitfalls and How to Fix Them

Redmond: Christine recently wrote an article called the error-proof portfolio, 5 common portfolio pitfalls and how to avoid them. So basically just common pitfalls that all investors seem to run into, or most investors, regardless of the person or stage of life.

Benz: Exactly, so one thing we try to do is say here some mistakes we see people make again and again and how can you take steps to make sure that you don’t fall into these traps.

Redmond: Okay great and I want to talk about the first pitfall what was it?

Benz: Well the first pitfall was having no clue about whether you are ready for retirement or not, it’s a big goal for a lot of people everybody knows that they need a lot of money probably more than they ever expected. They really don’t monitor their progress towards that goal as they go along and so they go through their 40s, 50s and 60s and may come into retirement and find that they are going to come up short, not have enough, and their only lever left will be to continue working. I say keep track of this as you go along. That way you can still do some things to make up for a shortfall before it’s too late.

Redmond: Okay great, and the second pitfall was holding too much cash which happens to a lot of investors.

Benz: It does and you know I think that it’s easy to see why this has happened recently we’ve had very volatile markets investors are still little bit shell-shocked after that huge global equity sell-off that we had in 2008 early 2009. So some investors are saying you know what I’d rather settle for that safe, but low return then venture into stocks. And the big risk of that is that right now cash, whatever cash instrument you have is yielding close to nothing. It’s very hard to earn a positive real return on your money.

So there is a huge opportunity cost to having cash, and so if you do look at your total portfolios asset allocation and find that you are too heavy on cash. My advice is to get a plan to deploy that cash over a period of months. Don’t move it into the market all at once, because the risk is that you could select the wrong time to put your money into the market, but actually plan to dribble it in over a series of months that way you can get your overall portfolios' asset allocation in line with your asset allocation framework.

Redmond: And the third one you read about was maintaining a stock-heavy portfolio close to retirement, but I don’t want you to talk about that right now because we are going to do that in our next video.

Benz: Okay.

Redmond: So we'll move to the fourth one which was?

Benz: It was avoiding portfolio sprawl. So one thing that I often observe—people send in their portfolios, we do these portfolio makeovers—people send their ‘before’ portfolio and sometimes you see literally 100 holdings. And it’s easy to see why that happens, households might have multiple accounts, multiple retirement savings accounts and maybe where you have two spouses both saving in their own names, often times you can end up with these very complicated portfolios. And there are a couple of risks of having too many holdings.

The first is that you have a portfolio that behaves a lot like the broad market but you are paying a lot more for that portfolio then you would if you just really narrowed down the number of holdings. And then the other big risk of having too many holdings is that you just have too much to monitor, there are too many moving parts in your portfolio and it’s hard to keep tabs on how all those investments are doing, whether there are any red flags happening at them. So I say it pays to periodically take a look at what you’ve got—aggregate all your holdings and see where you have situations where maybe you have overlapped.

So you have similar holdings geared towards a similar goal, but maybe you’ve got one that is really the stand out and another one that isn’t that good. Pare back the one that isn’t that good and move the money to the investment that is the better performer.

Redmond: And lastly it was ignoring tax considerations, that was a last pitfall and I’m guilty of that. So what are some things and tips for investors who encounter this?

Benz: Well, there are a couple of key things you can do, but certainly pay attention to what assets you are putting in which types of accounts. So you have some asset types that tend to be particularly tax efficient and they are good holdings for those accounts where you'll pay taxes from year-to-year.

So one reason we’ve seen index funds and exchange-traded funds getting so much traction over the past few years is because they tend to be very tax efficient. They tend to not kick off a lot in terms of taxable distributions and therefore are good holdings for taxable accounts. That's a good starting point, the other thing to keep in mind is, if you can take advantage of any tax sheltered wrappers for retirement savings, making sure that you are fully availing yourself of those options because you are able to obtain some tax benefits by investing in those versus investing outside of those account types.

Redmond: Great, thanks so much Christine.

Benz: Thank you Ashley.