4 Tips to Help Ensure Your Portfolio Is Keeping Up With Your Needs
Your life and goals are constantly evolving — and so should your investment portfolio. If it’s been a while since you’ve audited your portfolio holdings, it’s probably time to reevaluate. Conducting regular reviews of your investments is an effective way to protect your wealth and help ensure your portfolio continues to meet your needs. The following tips can help you get started.
#1 – Identify weaknesses.
Completing a portfolio audit allows you to identify weaknesses in your approach as well as opportunities for improvement. One of the most common portfolio weaknesses is overweighting a particular security or investment type. Allowing your portfolio allocation to become overly concentrated in a particular area can expose you to unnecessary market risk.
Another common portfolio weakness is deviating from your intended risk tolerance. It’s important to regularly audit your portfolio to make sure your risk exposure remains in line with your current risk tolerance. As your situation, goals and investment timeline change over time, be sure to conduct regular portfolio risk assessments to help ensure your actual risk is in line with your intended risk.
#2 – Review investment managers.
In addition to identifying weaknesses in your investment approach, it’s also important to regularly audit all investment managers to help ensure they continue to meet your needs. Important considerations include:
- Investment strategy
- Fees
- Track record
- Investment style
- Investment team
- Communication frequency
- Risk exposure
#3 – Evaluate your portfolio’s tax efficiency.
If you’re not taking steps to minimize your portfolio’s tax exposure, you could be missing out on significant growth opportunities over time. A portfolio audit allows you to identify opportunities to implement tax planning strategies such as those below.
Tax-loss harvesting
Within an investment portfolio, investors are only taxed on net capital gains, which equals gains minus losses. This means any realized losses could be used to help reduce your tax liability. Tax-loss harvesting is the process of looking for opportunities to realize losses in order to offset gains.
Tax-loss harvesting works by selling an investment that has declined in value in the short term (a common occurrence in a heavily weighted equity portfolio) and replacing the investment with a highly correlated alternative. If done correctly, your risk profile and rate of return remain unchanged, but the temporary tax losses are extracted in the transaction.
By realizing the investment loss, a tax deduction is generated that can lower your taxes. You can then reinvest your tax savings to further grow the value of your portfolio.
Asset location
Asset location refers to the strategy of dividing assets among taxable and non-taxable accounts according to each asset’s tax characteristics. Essentially, asset location allocates tax-efficient investments to taxable accounts and tax-inefficient investments to tax-advantaged accounts. When implemented correctly, this strategy can help minimize portfolio taxes and enhance returns.
Because stocks receive favorable capital gains tax treatment, it’s wise to place these investments in taxable accounts or Roth IRAs. If these assets are passed on to your heirs following your death, the heirs may be eligible for a “step-up” in cost basis, effectively resulting in zero taxation. Investments with lower return potential and unfavorable income tax treatment, such as U.S. government bonds and cash, should be placed in tax-advantaged accounts (such as traditional IRAs) to reduce their current tax exposure.
#4 – Maintain adequate diversification.
Having a properly diversified portfolio is one of the best ways to reduce your risk and maximize your wealth over time. Conducting regular portfolio audits allows you to evaluate your current level of diversification and take steps to improve on your diversification strategy.
As you review your investments, make sure they’re adequately diversified across asset types, asset classes, industries, market capitalizations, geographic regions, etc. Proactively monitoring your portfolio’s diversification can help you position your investments to better withstand market volatility.
Regular portfolio audits allow you to identify and improve on weaknesses, lower your tax exposure, maintain adequate diversification and mitigate certain investment risks. However, conducting a portfolio audit is a complex, time-consuming undertaking. Fortunately, the investment professionals at Creative Planning are here to help.
