In last week’s newsletter, we talked about the various steps to plan and track your investment portfolio. Now, let’s assume that most of us reading this do actively manage and assess our portfolios on a regular basis. What should we be watching out for once our investment goals are set and investment products purchased? How do we know if we should sit tight or bail when our investments are not going according to plan?

In this issue, we’ll address these problems by suggesting the common sign of trouble that emerge when your money is no longer working for you and trouble is on the horizon.

Invest time in a good Portfolio Assessment

It should be noted that even the best-laid plans can go awry when you subject it to the capricious stock market, especially for any extended length of time. As such, it’s not advisable to just create your portfolio and leave it there without reviewing it every now and then. Financial professionals and fund managers spend much time and money developing various matrixes and portfolio tracking ratios, complicated mathematical algorithms, which quantify and measure the “financial health” of their portfolios. These indicators help give them advance notice to switch their portfolio products before losses pile too high. Under normal market circumstances, these indicators do help make a better investment decision.

The bad news for those of us looking to use them is, some variables in these equations generally require some degree of educated guesswork, the algorithms are difficult and time-consuming to compute, and deciphering what the output means requires extensive knowledge of financial concepts, enough to overwhelm most of us.

The good news? With a healthy dose of common sense, alertness, and a bit of creativity, anyone can learn to spot the problems that these indicators were created to guard against.

Now that you know a little about how portfolio assessment works, let’s take a look at the common problems you have to watch out for in your portfolio. When untreated, the losses to your investments may balloon over time and depreciate the portfolio’s value.
 
Danger sign #1: The performance of your investments closely follows a single industry

Systematic risk (or market risk) describes a type of risk that does not diminish no matter how diversified a portfolio is in a certain industry. If industry-wide problems occur e.g. material shortages, most companies and earnings in that industry will be affected. Systematic risk can happen even if you invest in equities from different industries, so long as these industries have a close dependency on one another e.g. the property industry and materials industry.  Such risks are not necessarily bad, so long as you know they are there, but without tight supervision and closely monitoring of the events going on in that industry, there is a real risk of wiping out a large part of your investment capital should an industry-wide problem occur that devalues stock prices in that industry across the board.

Suggestion

Given that you want to diversify your portfolio to reduce risk, not increase it, you should consider focusing your investments on different industries with no apparent dependency on one another.

Danger sign #2: The volatility of your investments do not match your risk profile

Volatility refers to how much the value of your investments fluctuates over a length of time. Risk profile refers to how much risk an investor can afford to take. If the fluctuations are small and stable, this usually means the investments of the portfolio tend to be low-risks, low-return. This benefits a cautious investor who will rather take a small profit than lose money. On the other hand, if your volatility is high, the resulting potential returns should be higher. The issue is not whether the volatility in your portfolio is too high, it is whether the portfolio returns follow your expectations. A portfolio where the volatility does not match the risk profile of the investor is not adhering to its investment goals and therefore stands less chance of achieving the projected returns of the investor.

Suggestion

A simple way to increase volatility is to change the ratio of each type of investment product in your portfolio. For instance, you can change the portfolio composition from 20% equities, 40% bonds, 40% funds, to 40% equities, 30% bonds, 30% funds. As a general rule, derivatives such as options and warrants are most volatile, followed by equities, mutual funds, ETFs, bonds, fixed deposits, and savings.

Danger sign #3: Your returns do not cover expenses incurred while investing

By expenses, we mean brokerage fees, sales charges, management fees etc. Left untracked, this can easily get out of hand. If you are not a speculator, i.e. one who chases trends and trades on a large volume daily, your brokerage fees should not be exorbitant enough to take up any substantial amount of your returns. The bulk of the expenses should come from mutual funds in the form of annual management fees and miscellaneous expenses. A situation where the returns do not cover expenses only occurs with low returns coupled with high expenses.

Suggestion

The following may apply more to mutual funds and unit trusts as they are the ones generating more expenses. As the expenses are paid in return for professional expertise and performance, it is important for the investor to assess the fund manager in return. Firstly, many investors, when the fund underperforms, look at past performance to determine if they should hold or sell.

Although past performance is an important consideration to gauge future performance, it is by no means foolproof. Instead, look at the investment strategy of your investment manager. Is he cautious or bold? Has his investment strategy changed recently? Is it in line with your own risk profile and investment goals? In addition, check out the industry the fund operates in. Is the growth of the industry strong? Is it slowing down? An industry reaching market saturation may not yield the same returns for the fund, especially if the investment strategy of the manager remains unchanged. Finally, look at the countries it operates in. Is it investing in local firms? Is it investing globally? Generally speaking, the smaller the geographical area of the investments, the higher the systematic risks will be. After assessing all these options, you should have a clear idea whether the fund stands a good chance of performing well in the future.

Armed with our suggestions on how to troubleshoot your portfolios, do you think Singaporeans in general actively manage our portfolios? Tell us your thoughts in our question of the week!
Have a good weekend!

Yours Sincerely,
Tony Koh   
Webmaster, Qotion.com