I generally like the buy and hold investment strategy.
Assuming, that is, you passively invest in a well-diversified, low-cost portfolio.
But I think that a buy and hold strategy needs a little tweaking for best results.
One such tweak involves the need for periodic portfolio reviews.
There is no hard and fast rule as to the frequency of portfolio evaluations. The number of reviews should reflect a few factors. As these differ between investors and their portfolios, so too will the periodicity of portfolio assessments.
Portfolio Risk Level
The timing of evaluations should be connected primarily to the risk of the portfolio.
With a relatively low risk, well-diversified portfolio of mutual and exchange traded funds, annual reviews may be adequate.
As portfolio volatility (i.e., standard deviation) rises, you may want to increase the frequency of evaluations. Maybe semi-annual reviews for portfolios with moderate risk levels. Perhaps quarterly reviews for portfolios with high standard deviations.
For portfolios that are not well-diversified, quarterly to semi-annual assessments are prudent. This holds true even for lower risk portfolios. And the less diversification, the greater the need for more frequent reviews (the exception being for single investments in extremely low risk assets such as Treasury bills, term deposits, etc.).
The logic of increased frequency for high risk or weakly diversified portfolios is that external factors can have significant and rapid impact on highly volatile and/or non-diversified investments.
For example, perhaps you have a large concentration of investments in the Middle East. Given all the political turmoil there, you would want to monitor your assets very closely. If you wait a year to do an evaluation, you may find that the situation when you last reviewed has radically changed concerning your holdings.
General Market Volatility
Over time, certain events can cause excessive volatility in the markets. Most of these are systematic risk factors. In our Middle East example above, socio and geopolitical variables can impact individual investments.
On the down side, events may include inflation, high unemployment, political turmoil, stock market crashes, wars, natural disasters, and so on. On the positive side, there may be long bull markets due to the opposite events, such as low unemployment, low inflation, peace, etc.
The greater the general market volatility, the greater the focus should be on your portfolio.
In part because strong systematic risk events can have wide ranging impact on one’s investments. Unlike nonsystematic risk factors that you can minimize through proper diversification, it is more difficult to protect against systematic factors.
And, in part, because a well-diversified portfolio of passive index funds should reflect the market itself. As general market volatility increases, so too does your portfolio. Therefore, you should increase your amount of reviews accordingly.
Investor Personality
Periodicity of portfolio reviews will also reflect your personality and investor risk tolerance.
Not that it should, but an individual’s personality plays a role in how they manage their assets.
If you are a detail oriented person, you will likely be more comfortable reviewing your assets monthly, or even weekly. No doubt using spreadsheets or investment software to drill down into the numbers. If you are quite relaxed about life, then even an annual check-up scribbled on the back of a napkin may feel onerous.
The same applies to one’s investor risk profile. Low risk investors will normally want to monitor their portfolios more closely than a high risk investor. The opposite of what should be done, but it ties into their personality in many cases.
Given the importance in generating adequate wealth for a comfortable retirement, I suggest you set aside any personality traits that lead you to defer reviews. Put in a little time now on performing proper evaluations and you will reap the benefits down the road.
Material Change
A material change is anything that alters your investment perspective.
That could be a systematic variable that impacts your portfolio. War, hyper-inflation, depression, etc. Factors that affect economies and have wide ranging impact on investments.
Or nonsystematic – company specific – variables. The Department of Justice in the U.S. going after Facebook or Google. An oil company you own shares in, undergoing a takeover.
Material changes also reflect your own life. Young, single, you may design a higher risk portfolio. Get married and have a child, perhaps your risk profile lessens. Life insurance becomes an interesting topic.
A material event may be far reaching in impact. Or it may relate to a specific investment. Or the world may remain the same, but features of your life change.
A material event needs to be addressed in real time, not as part of an annual review. If your mining company is being investigated for environmental destruction in January, you likely do not want to wait until December to consider the impact on your investment.
That said, there is lots of media “noise” out there, over-emphasizing variables both too good and too bad. Things that cause assets and markets to swing wildly, only to reverse back to normal in the near future. It takes a bit of experience and knowledge to sort through the wheat from the chaff.
What Next?
Okay, so you should review your investment portfolio periodically.
But how should you efficiently do a review?
And what should you do after a review?
Good questions.
We will look at portfolio benchmarking and review procedures over the next few weeks. Then we will cover what to do if your portfolio gets out of alignment with your investment plan.
