By John Wasik
CHICAGO Feb 4 Whenever the stock market
breaches an old high - like when the Dow closed over 14,000 on
Friday, the best mark since October, 2007 - it is time to look
inward, not outward.
You could be happy that your portfolio looks pretty good, or
you could remember how you felt in 2007 after feeling
optimistic, then only to be crushed soon.
Given that you probably have a lot of year-end and
tax-related statements coming in right now, you will see a lot
of material to evaluate your investments. What to do next? Sell
off winners? Hedge against a fall? Pick up laggards before they,
too, go on the upswing?
The trouble is, most investors do not really know how to
evaluate their portfolios.
It might sound simple to just look at annual returns and see
how you are doing, but when I review my family's portfolio, I
ask some detailed questions. I do not always like the answers,
but at least I have some guidelines for what needs to change.
Much, if not all of my analysis, is actually done by my
mutual fund company, but I have to call to find where on my fund
company's website the information on returns is stored.
One key is that when you do your own review, always ask for
net returns after expenses and taxes. If your money manager
provides inflation-adjusted returns, that is a big plus that
gives you a baseline to see if you are moving ahead - or falling
behind. Here are some other questions you need to consider:
1. Is your portfolio beating inflation?
At the most basic level, beating inflation is a pretty good
benchmark for most portfolios, although not a perfect one. While
the U.S. government's Consumer Price Index (CPI) is a flawed
gauge, it gives me some idea of whether I am keeping up with the
increase in the general cost of living when I look at my own
Last year, the CPI rose some 1.7 percent, although I know
that medical and college expenses are at least double that.
Health spending climbed almost 4 percent in 2011, the most
recent year available, according to Health Affairs, a policy
Since my family is particularly sensitive to medical and
college expenses, I use a personal inflation gauge that targets
these costs. So if our portfolio does not return more than 4
percent after fund expenses, it is not keeping up with the kind
of inflation that hurts us most. Fortunately, it did, instead
turning in a 12 percent net return after expenses, which is
There were no taxes, since this is a retirement portfolio.
Over five years, though, it is a close shave, with a 4 percent
gain. Since that included the 2008-2009 meltdown, it is not too
terrible, but nothing to brag about.
2. Are you meeting other benchmarks?
My wife and I decided that we feel most comfortable with our
portfolio split 50-50 between stocks and bonds. We made this
decision after 2008, when we lost close to 40 percent of the
portfolio's value on paper due to a 70 percent-plus stock
allocation. If you are in your 20s, then you might prefer to
take more risk and go with a 60-40 mix.
I double-checked my year-end statement to see if we were
near our target allocation and we pretty much are, so no changes
were necessary. You'll need to monitor your mix at least once a
year to see if you drifting off course.
You will also want to measure your returns against a
benchmark fund, to see if you are getting the most out of your
investments. Since most "balanced" benchmarks are a 60-40 mix, I
had to rely on a hybrid benchmark used by a Vanguard Target
Retirement 2015 Fund, which had a rough mix of 55
percent in stocks, 3 percent in cash and 42 percent in bonds as
of year-end 2012. It's not a perfect match, but close enough.
Again, we were doing okay, since we beat this benchmark by
almost a percentage point. The idea here is to match your
portfolio with the appropriate benchmark fund, which gives you a
basis for after-expense returns. For holdings dominated by large
U.S. stocks, use a S&P 500 index fund. For bonds, use the
iShares Core Total US Bond Market ETF, which I hold in
3. Are you matching historical return ranges?
I always like to know if I am within a target range of how
my portfolio should perform, given its composition. This is
always a bugaboo for investors because few can match the
performance highs over long periods of time. In my particular
mix, the best year was a 34 percent gain in 1933. It is also
good to check your downside risk. The lowest point of my
portfolio was a 24 percent loss in 1931.
If your downside risk is out of line, your returns will be
too, so you may need to adjust your allocation to include more
bonds. That is what we happened to us in 2008, when we
approached the worst recorded year for stocks in the 20th
century, in 1931. But after rebalancing, we now seem to be on
4. Are you missing out on something?
Do not try to guess whether the market will go up or down,
but instead figure out where you need to be. This is a good time
to have an investment policy statement, which spells out in
writing how much you want in each asset category, depending upon
your risk capacity.
Then you do not have to think about jumping into
opportunities that may be risky, or selling off winners that may
gain even more after you sell them.
The name of the game for most investors is preservation of
capital. It's not about what you make on the upside, it is what
you keep on the downside. You may need to rebalance or add
growth stocks. Just take your time and do not feel like you are
late to the party when the market soars. Look at it as just
another opportunity to ask yourself if your portfolio is
following your plan. The market has a mind of its own.