The past few years have been a rollercoaster ride for investors. After over a decade of largely uninterrupted gains for equities markets powered by growth stocks with Big Tech at the vanguard, extreme volatility and a bear market are realities again. For younger investors, it will have been the first such experience of volatility and sharp drops in valuations.
Efforts by the Fed and other major central banks like the Bank of England to curb inflation led to an increase in interest rates, resulting in a decline in both the stock and bond markets. Few sectors delivered positive returns last year but investments such as energy stocks, commodities, and managed futures funds did perform well. However, these types of investments typically make up a small portion of most investors’ portfolios.
That’s especially the case for younger investors whose portfolios are often heavily weighted towards growth stocks, which were one of the worst performing categories of equities in 2022.
Investors should refrain from over-reacting to bear market conditions
One of the central pillars of long term investing is to avoid reacting to temporary market volatility. If an investment portfolio’s strategy is sound and it is comprised of high quality assets that align with and support that strategy, you shouldn’t have to make significant changes in response to a bear market. Even if it can be hard to sit tight and keep focusing on the underlying quality of assets and their long term potential when valuations have plunged.
Why you should still review your investments annually
However, that doesn’t mean an investment portfolio shouldn’t be periodically reviewed. Things can change both with regard to the broader market and individual assets and while portfolio adjustments should be made conservatively, sometimes they should be made.
Disciplined investors with a well thought-out portfolio can use an annual review to potentially make some changes, within the context of the existing strategy.
How to carry out a review of your investments step-by-step
If you go through the following steps as part of an annual review of your investment portfolio, it should be well maintained with a view to it meeting its long term goals. And without you having to spend time and mental energy on it over most of the rest of the year. Once you’ve gone through your annual portfolio MOT, you should be able to relax for another twelve months.
- Progress Check
The first stage of an annual portfolio audit should be a big picture assessment of progress towards investment goals. If you are investing towards a pension pot, for example, and expect to start drawing down from it in 10,15 or 20 years you should calculate if the current cash value of your portfolio, plus conservatively expected long term compound returns (eg. 5% a year) and planned ongoing contributions will see you reach your target value.
If you have been investing 10% of your monthly income, will continuing to do so at that level take you to your target by the time you expect to start drawing down? If not, can you increase contributions to 15% or 20% of your regular income to get back on track?
If you are already retired and drawing down from your investments, assess your current rate of spend compared to remaining value and conservatively expected returns. Do you have enough value left to keep spending at your current rate for as long as you need?
- Asset Allocation Review
When you first set your investment portfolio up, you should have decided upon an asset allocation mix judged as most likely to best support you achieving your investment goals. For young investors a long way from retirement, it wouldn’t be unusual for 80%-90% of a portfolio to be invested in equities.
A typical asset allocation model would be to start at 80% equities and 20% fixed income (usually bonds and bond funds) and then gradually increase the fixed income allocation to 30% or 40% over time. However, the performance of one asset class over time could see that balance change.
For example, despite a bad year for equities in 2022, outsized returns over a three year period would mean a portfolio that started with a 50/50 split between equities and fixed income in 2020 would now be roughly 60/40 in favour of equities. If the reasoning behind the original 50/50 split hasn’t changed, some equities should be sold off and the cash reinvested in fixed income to rebalance the asset allocation.
There might be planned allocation within a broader asset class like 50% of equities investments being made in growth stocks and 50% in income stocks. Keeping that balance would require occasional adjustments if one asset sub-class eg. growth stocks, performs better over a period.
Some annual asset allocation rebalancing is likely to be necessary either because the long term plan is to increase the allocation towards lower risk and fixed income investments over time or because market movements have shifted the balance without any assets being bought or sold.
- Are cash reserves sufficient?
It’s usually advisable to have at least 3-6 months of basic living expenses to hand in cash to avoid having to sell investments at an inopportune moment if emergency funds have to be accessed. For those already relying on cash drawn from an investment portfolio as their monthly income, that should be extended to around 2 years.
Holding cash also means you have the option to increase contributions to an investment portfolio during bear markets when assets are discounted. The best returns are achieved when high quality assets are acquired when general market sentiment is negative and then benefit from a return to a bull market.
It also makes sense to review where you are holding cash. Could you be getting a better interest rate by moving it into a different account?
- Review individual investments
If the bulk of your portfolio is invested in funds tracking major indices like the FTSE 100, S&P 500 or MSCI World, this hopefully shouldn’t involve a lot of work. But if you are invested in a variety of managed funds and individual stocks, you may be faced with a more significant task.
Funds should be reviewed for price and performance against equivalents and if they are thematic, for example an Asia Pacific fund, is the original reasoning for deciding on investment exposure to Asia Pacific still sound?
Individual stocks, if there is an allocation to them, should also be reviewed. For example, Meta Platforms stock may have delivered fantastic average returns for the past 5 or 10 years despite heavy losses in the past 12 months since being originally purchased as Facebook shares. But are you confident the company will make up for the declining relevance of Facebook as a social media platform by its huge investments in a future, as yet undefined, metaverse?
Maybe it’s time to lock in longterm returns despite losses over the past 12 months and reconsider the stock in another year or two when there is more clarity around the metaverse gamble?
- Are your investments tax efficient?
Finally, you should assess if your investments are being made and held in the most tax efficient way. Are you taking advantage of tax efficient ISA and SIPP allocations available to you when investing? There are other investment vehicles and structures with tax advantages such as EIS/SEIS investments and VCTs that might be compatible with the asset allocation strategy of some portfolios.
An annual review of an investment portfolio doesn’t need to be hugely time consuming or complicated. Especially if you haven’t made a lot of investments in individual stocks or a large number of different thematic funds. If you have such investments and are struggling to find the time to properly review these holdings annually, that is quite possibly a sign your review should involve adjustments to your portfolio. Your asset allocation should be annually reviewable within the context of your personal circumstances. Simplify your portfolio if it is too complex for you to properly manage.
If your overall strategy is solid, small adjustments, if any, are all you should need to make annually to keep yourself on track to meeting your investment goals.
