Spring cleaning works for investments, too

Hey there, time traveller!
This article was published 07/04/2018 (2796 days ago), so information in it may no longer be current.

Despite what the calendar states, spring remains just around the corner. Still, those rites of the season — cold-weather barbecuing, over-consumption of chocolate eggs and, of course, spring cleaning — are upon us.

While no one can argue against a thorough tidying of the house itself, it’s also worth sorting through the investment portfolio, cleaning out those money-losing dust bunnies that are clogging the cogs of your wealth-building machine.

“OK, then, where to begin?” you might ask.

Consider these tips — not just to clean up, but to polish your portfolio into a golden egg-laying goose.

The rebalancing act

Portfolio manager Doug Nelson says spring is the ideal time to get deep in the reeds of your portfolio to weed out trouble spots.

“We know that North American stock markets in general have a bit of seasonality to them, where the bulk of the returns are earned from October to mid-May every year,” says Nelson, president of Nelson Financial Consultants in Winnipeg. “So, if the bulk of the returns are earned throughout the winter months, then spring cleaning makes perfect sense.”

The best way to start is by taking a broad view of your holdings and whether the asset allocation mix — your blend of stocks, fixed income (bonds and GICs) and cash — reflects your needs.

“What is your asset mix today — the offence and defence, or between equities and fixed income?” asks Nelson, author of Master Your Retirement: How to Fulfill your Dreams with Peace of Mind.

“Has this formula changed significantly since the last review?”

Let’s say you are a balanced investor, meaning your ideal mix is a portfolio with 50 per cent of your capital allocated to stocks and 50 per cent invested in bonds and cash. But, thanks to a surging stocks market, your portfolio now consists of 65 per cent stocks and 35 per cent bonds and cash. So you need to bring the asset allocation back to that original 50-50 mix.

“Then you need to ask, ‘Among the stocks, funds and ETFs, what investments should I be looking to sell?’” says Ted Rechtshaffen, a certified financial planner with TriDelta Financial in Toronto.

Just a little off the top, please!

These days, more investors are looking to sell stocks to rebalance their portfolio, because equities have done very well. In contrast, bond holdings have stagnated or fallen in value. And investors have many ways to go about selling equity holdings. One of the more popular strategies is trimming investments that have outperformed the rest of the portfolio.

“It may make sense to take some of those profits and re-diversify, all under the heading of managing your risks and not doubling down on your winners,” Nelson says.

The beauty of this exercise is it forces you to look at other potential red flags, such as concentration risk whereby one holding exposes you to too much risk in one company or one economic sector. If that stock, or its sector, runs into trouble, the negative impact on your portfolio may hurt more than it should. Rules of thumb can vary how you determine if one investment weighs too heavily in your portfolio, says stock analyst Scott Clayton with TSI Wealth Network, which offers do-it-yourself advice. But, if “a single stock represents, say, 10 per cent or more of your portfolio, it exposes you to a high degree of risk,” he says, adding the best way to reduce risk is selling some shares to realize a portion of those profits.

Get that garbage outta here!

In the words of Toronto Raptors colour commentator Jack Armstrong, sometimes you just have to “Get that garbage outta here!” In other words, occasionally, we make bad investments that just need to be sold, Rechtshaffen says.

“That’s not so much of an investment decision,” he says. “It truly is like spring cleaning, because you’re trying to put the old stuff behind you.”

So what might qualify as garbage? Those “I bought a stock for $10 a share and now it’s worth 30 cents” investments are ideal for liquidation.

“Sometimes, people have take a step back and an unemotional view and go, ‘That $10 stock really is only worth 30 cents.’”

On a related note, it even makes sense on occasion to sell the entire position for a high-flying stock, because perhaps market conditions have changed for the company, and its lofty price is only going to fall in the future.

“Nobody knows what the future holds, so you try to be scientific about it,” Nelson says.

Unfortunately, too many investors have few criteria that dictate why they hold a stock beyond the fact it has been profitable.

“That is why you need five to seven different guidelines determining why you would buy, hold or sell something,” he adds.

The rules can differ by the individual, but they can ultimately help you unload strong performers before they tumble in price with changing market and economic conditions. Otherwise, you could end up like many Nortel investors in the early 2000s, when the Canadian tech giant went from a triple-digit stock price to zero, dragging along with it the retirement dreams of many who held on, hoping for a recovery that never came.

OK, I’ve made the cuts. Now what?

You’ve trimmed back, and even sold some stocks entirely. Now you’re left with another dilemma. Figuring out what to buy. If you’re retired or close to it, you might want to invest the profits in near-cash securities like GICs, or a money-market fund. For bonds, most experts suggest avoiding anything long term. So, steer clear of fixed income with durations of 10 years or more. The reason being interest rates are moving upward, Clayton says. And that affects the value of your existing bond holdings.

“Bond prices and interest rates are inversely linked,” he adds. “When interest rates go up, bond prices go down, and vice versa.”

This isn’t entirely awful, because rising rates generally reflect improving economic conditions. Moreover, only the value of your bond is affected negatively, and a loss is only incurred if you sell it before it matures (expires). But, the best way to avoid significant losses in fixed income is to buy short-term bonds.

Not only do they fall less in value in a rising rate environment, their shorter maturities allow you to turn over your fixed-income holdings faster to buy higher-yielding bonds that come with a rising rate environment.

Sector selector

Even if your asset allocation for the most part reflects your original mix — like 60 per cent stocks and 40 per cent bonds and cash — your portfolio may still not be properly diversified. Beyond those three asset classes, you want to “spread your money across most, if not all, the five main economic sectors,” Clayton says. These are manufacturing and industry, resources, consumer (goods and services), finance and utilities — though you can break it down even more adding technology and health care, among others. But the point is by ensuring you own stocks and even bonds in most, if not all, of these areas, “you avoid overloading yourself with investments that are about to slump simply because of weak industry conditions.”

Clayton adds another upside of diversification is that it increases the chance “of stumbling upon a market superstar.”

If you’re new to investing, with not much cash to put to work, you can still take these tips to heart. Only rather than buying and selling individual stocks and bonds, mutual funds or exchange-traded funds (ETFs) should be more your thing.

The upsides are many — instant diversification, built-in management, and quick and easy trading. The only task left for you is rebalancing, which generally involves selling a broad-based equity fund (like one holding the most popular stocks in the U.S.) and buying more of a broad-based bond fund. Investors still have plenty of choice among funds — ones that use different investment strategies, cover certain sectors and focus on specific geographies.

Not a DIY investor?

All this advice still applies, even if you’re working with an investment adviser, Nelson adds.

“Advisers can be very busy and may not be looking at your portfolio in a timely manner, so it is really healthy for your money to spend time doing your own spring cleaning. That way, you have questions the next time you see your adviser.”