Over time, investors find their portfolios become increasingly complicated and cluttered. I was surprised a few months ago when I looked at my situation and discovered I had several accounts with various discount brokerages. Not only that, but I had been trying a few investments here and there, resulting in overlap. I also had random assets that didn't really fit my investing plan. My portfolio had, with very little effort on my part, become complex and bloated.
I immediately began getting back to basics, re-examining my long-term investing goals and trying to decide how to simplify my portfolio.
The good news is that, far from causing quality problems, simplifying your portfolio is likely to improve the quality of your portfolio.
Focus on Asset Allocation
“Academic research shows that one important determinant of portfolio returns is asset allocation,” says Mathew Dahlberg, a Registered Investment Advisor and the owner of 111th Street Investments LLC. “It is vital that a portfolio is properly diversified across multiple asset classes and, just as important, that the allocation is rebalanced from time to time.”
The first step to simplifying your portfolio is to evaluate your long-term and short-term investment goals, and figure out how they fit into your overall financial plan. Once you know what you want to accomplish, you can use that information to create an asset allocation that works well for you.
A focus on asset allocation means you don't have to worry so much about picking individual investments. Instead, you look at classes of assets and focus on holding the right proportions of those assets.
A proportion that is right for you depends on your goals, as well as where you stand right now. If you plan to retire in 30 years, an appropriate asset allocation might include 80 percent stocks and 20 percent bonds, depending on your risk tolerance.
Other investors, who are interested in additional assets, might decide on an asset allocation that more closely mirrors their goals, such as 70 percent stocks, 10 percent real estate exposure, 10 percent bonds and then 5 percent each of cash and gold. What works for you depends on your feelings about the future and what return you hope to get out of your portfolio.
Once you have established your desired asset allocation, it's a fairly simple matter to rebalance between two and four times a year. When an asset class has increased enough that it takes up too large a portion of your portfolio, you can sell high and buy more in another asset class where the prices are lower.
This helps you rebalance your portfolio and is a simple way to follow one of the basic rules of investing: buy low and sell high.
Use ETFs to Maintain the Proper Asset Allocation
Unfortunately, a focus on asset allocation can be complex and messy if you are buying individual companies for the stock portion of your portfolio and buying individual bonds for that portion of your portfolio. “What kind of person not in the finance business has the time and knowledge to make sure that their account allocation doesn't deviate too far from their chosen levels?” asks Dahlberg. “Who has time to research and follow multiple companies and keep on top of their industries?”
Combining the principle of asset allocation with the purchase of exchange-traded funds (ETFs) is one of the best ways to simplify a portfolio while still maintaining quality. ETFs are groups of assets that trade together as one investment. Not only that, but ETFs can be bought and sold like stocks on exchanges, making them very easy to manage.
“ETFs provide instant diversification, track types of major indices and, just as important, have very low costs,” Dahlberg says. “Choose your initial, inexpensive allocation and rebalance as your needs dictate.”
With ETFs, it's possible to hold only a few investments in your portfolio, yet still be properly diversified. “In order to streamline a portfolio, there is no real need to hold more than ten or so ETFs,” Dahlberg says. This makes it easy to avoid overlap and to rebalance as needed.
Dollar-Cost Averaging and Robo Advisors
You can also simplify your portfolio with the help of dollar-cost averaging and the use of robo advisors.
With dollar-cost averaging, you invest the same amount of money each month, and your investment is divided up into the appropriate asset allocation. Most brokerages allow you to create an automatic investment plan that allows you to dictate your monthly investments.
If you can invest $500 per month and you have three different ETFs reflecting 70 percent stocks, 20 percent bonds, and 10 percent gold, your money will be automatically invested as you wish. When your automatic investment is made, $350 will be used to buy more shares of your stock ETF, $100 will go toward your bond ETF, and the remaining $50 will go into your gold ETF.
Robo advisors make this process even easier. Robo advisors will help you work out an appropriate asset allocation based on your goals and risk tolerance and then allow you to set up an automatic investment plan.
These rob-advisors will also rebalance your portfolio for you when it strays away from your ideal allocation by more than 5 percent or so. One of the reasons my Roth IRA is held with a robo advisor is because I know I don't have to worry about rebalancing my portfolio. It's all done with ETFs, and someone else takes care of it for me.
When I simplified my portfolio a few months ago, I mainly liquidated my assets in other accounts and then divided them between my Roth IRA, HSA and the taxable account I use for my emergency fund. I had enough contribution room in my Roth and my HSA to add a little more, and it was easy to make sure my asset allocation remained constant.
Next time you look at your investment portfolio, consider whether or not its complexity is adding to your cost and slowing down your returns.
You might be surprised that simplifying your portfolio boosts your returns over the long haul.