One of the primary reasons that we put so much emphasis on establishing goals and calculating a required rate of return is to build structure around investment decision making. As investors we want to be intentional with the actions we take as this will limit mistakes and allows us to capture the benefits of behavioural edge. 

Additional resources: 

Article: Defining an investment strategy

Article: When should you sell shares?

Podcast: How to evaluate investment performance available on Apple Podcasts, Spotify and Google Podcasts. 

Proceed to Module 8: How to set yourself up for investing success: Selling down investments to fund your goals

Investments are a means to an end. Mark LaMonica, CFA goes through the process of selling down your investments to fund your goals.

Back to course outline.

Module transcript

Mark LaMonica: In our next module, we're going to talk about monitoring and maintaining your portfolio. And before we get into some specific steps, let's go back and once again go through the process that we talked through so far during the course. And what we've been trying to add and what we've emphasized is we want to add structure around decision-making, and we want to make sure that the decisions we make are within the context of what we're actually trying to achieve. And of course, that is your goal.

And before getting into what you should do, let's talk about how many investors monitor and maintain their portfolio. Well, everyone wants to know how they're doing. And so, of course, what people look at is performance. And they will look at performance of their overall portfolio, and they will look at performance of individual investments that are sitting in their portfolio. And of course, this is something you're going to do. But the problem with looking at performance and isolation is you can't tell if that performance is good, as in it's allowing you to make progress towards your goals or it's bad. And so, what we then start doing is we start comparing performance. And what this causes a lot of investors to do is to churn their portfolio. It means they're buying and selling things frequently in their portfolio, which leads to a lot of bad outcomes. When we went back and we talked about risk and reward, and we talked about what you're really trying to achieve as an investor is a return in excess of inflation and in excess of any fees that you pay. So, both those transaction costs you have by trading different assets in your portfolio, the fees, of course, you're paying to anybody who is managing that money in a fund or an ETF, and then of course, your tax outcomes, which generally occur, capital gains tax, when you're buying and selling things. So, we want to minimize all of that. And basically, what we want to do is we want to minimize the amount of transactions that we have.

So, investors that don't have the context when they're making these decisions are more often going to churn their portfolio, as we said. And one of the big problems with this is many investors chase performance. So, if they hear about a share or a fund or an ETF that's performed really strongly, they will compare that performance generally over a short time period to what's in their portfolio, and they will decide that that performance will continue into the future, and it's a good opportunity for them to switch. Any investment in your portfolio is going to have over the long term some periods where it does well and some periods where it doesn't do as well. But we want to make sure that we are looking at that long-term performance, that we are not having all those bad things happen around transaction costs and taxes and fees that we pay. And that's why we want to put the context of your goal and how you're tracking against your goal at the forefront of any decisions we make.

And even though it seems like a good idea for investors to trade something that is not performing as well over the short term with something that is performing better, there are countless studies that show that this is a terrible way to actually manage your portfolio. And one of the most famous studies is a study out of the University of California at Berkeley that went in and looked at retail client accounts, so basically, accounts that you and me have with our brokerage account. And what it measured was how the asset that you sold, so that stock, ETF or fund that you sold, performed in the future against something you went in and bought. And it found out that if we look at 504 trading days after that transaction, after something was sold and something was bought, it showed that the investment that was actually sold on average outperformed the one that was purchased by 3.32%. And that's a large number. And it's a large number, especially when we start including those other costs, what you're buying and selling those transaction costs associated with that, and certainly any taxes you would have to pay. So, that's the last thing we want to do. And we'll spend some more time talking about this, but you do need to have a really high hurdle rate before you actually go out there and sell an investment because it's hard to make up for all those costs, the taxes, and of course the fact that most investors are moving into investments that have not performed as well.

So how do we want to look at portfolio performance? Well, the first thing we want to do is we want to compare it to the return that you need in order to achieve your goals. So, it's a really good marker. If you need a 7% return in order to achieve your goals, look at your portfolio performance within that context. Looking at it against an index over the short term is not necessarily a positive thing. Looking at those individual investment performances against how some other ones performed is not a good thing. Focusing on and tracking towards that goal is how you want to manage your portfolio.

The other thing that we've talked a lot about throughout this session is the importance of asset allocation and why asset allocation is a bigger contributor to your overall portfolio performance than those individual components of your portfolio, those shares, funds, and ETFs that you go out there and buy. And so, when we're monitoring portfolios, the other thing we want to do is monitor our current asset allocation against the asset allocation that's back in our goals, that we put within the context of our investment policy statement. Because over time, different asset classes will have different relative performance. So even if you wanted to, in a very simple example, have 80% of your money in shares and 20% in bonds, how those two asset classes perform is going to throw that out of whack. So, if you don't monitor that, all of a sudden, you could discover that your portfolio is 90% in shares and it's 10% in bonds. And that's an asset allocation in this case that is not what's in your investment policy statement and not what you need to achieve your goals. So rebalancing is simply the act of moving money from something, an asset class that has performed better than another one, to get your portfolio aligned with where you want it.

Now, a couple of things about rebalancing. The first thing is obviously rebalancing has some negative impacts on your portfolio as well, because you are paying those transaction costs, those taxes to rebalance. So, we want to rebalance in a smart way. And what we want to do is minimize actually selling investments. And we can rebalance simply by the money that's going into our portfolios. So, it's a way that we can slowly rebalance our portfolio and a way that we can get it back into line or at least closer into line of what we want just by moving new money into an asset class that's underrepresented.

The other thing about asset allocation is remember it's a guide. It doesn't need to be exact. The last thing we want to do is rebalance too frequently. The last thing we want to do is rebalance every time there's a couple of percentage point changes in our portfolio. And this is where we can look at different approaches to rebalancing. So, the first approach is you don't want to do this too often. So, we recommend that you wait at least a year, or every year is when you're going to go back and look at your portfolio and see that asset allocation and where it is. So, what that will allow is for that volatility or changes in prices over a longer period of time, in this case a year, to play out without you making other moves.

The other thing that a lot of investors do is they will actually set bans around asset allocation. So same example, if we want 80% in shares and we want 20% in bonds, we wouldn't rebalance even after waiting a year if it just simply went to 81% and 19%. We'd want to put a band around that. So, whether that's 10% or 5% is really up to you. But what that band can do is it can allow the natural volatility in markets to play out without going through this rebalancing act.

And then I was talking about seeing how you're tracking against your goals. We once again want to take a long-term perspective of this. So, if your goal is to achieve a 7% return a year and you get a 5% return or, depending upon market conditions, you actually have a negative return for certain years, that's expected. And we're always going to see these downturns when we're investing over the long term. These downturns are what we need to deal with as an investor. So don't get worried that you're not going to achieve your goal. What we want to look at is instead of a yearly performance against our required rate of return, we want to look at changes in that required rate of return. So back in the second module when we talked about goals, we talked about all the different things that we need to define a goal. So, we need to understand how much money we need to achieve that goal. We need to understand the time period that we have to achieve that goal, how much we're saving, and of course how much we have now.

So, you can recalculate that required rate of return at any time because you're going to have all those same inputs. Now you may adjust them as your goal changes, but you'll still have those inputs, and you'll always have that required rate of return from any point in time. So, as we talked about, as you get closer to your goal, of course, that time period will shorten. If your savings perhaps have changed and you're able to save more money or you go through a period of time where you can save less money, that's going to adjust that and then the performance of your portfolio is going to adjust how much you have. So, when we recalculate that required rate of return, we can see if it's going up or down. So, a required rate of return that increases, so let's say, you went from that original 7% to 7.5%, that does mean that you're falling behind your goal. But we can still go back and do that reasonableness check to see if 7.5% is actually achievable without making large changes to what we're doing. And in most cases, you're going to see very small fluctuations in that required rate of return. If it actually goes down, so in this example, if it went from 7% to 6.5%, it means you're actually ahead of your goal. But once again, we don't want to panic with small changes unless the change is extremely large, then we don't want to make any changes to what we're doing. But if, for example, you do get a very large change in that required rate of return, let's say, it went up significantly. So, it went from 7% to 10%, which likely means that over a number of years, you're falling behind that return you need or you're not meeting your savings goals, then we might want to make some adjustments.

First adjustment is going back through that same process, looking at asset allocation. Do you need to be more aggressive? And there is obviously a limit to what your returns are. So, it's often other adjustments that we'll have to make when we're doing this portfolio review. We can also adjust other inputs to get you back to a place where you're comfortable you're going to achieve your goal. So, you can save more by saving more money. Of course, you're going to lower again that required rate of return. You could delay your goal potentially. So instead of, in the example that I used earlier, 16 years to retirement, instead of retiring at 60, in my case, I could push that back a couple of years. That will lower your required rate of return. Or of course, we could potentially adjust that goal. And then of course, the same thing can happen if you've gotten to a point where you've earned returns or saved more to get that required rate of return significantly below what you originally had. So, all of a sudden, if you go from 7% down to 4%, you can make the same adjustments, but this time obviously beneficial to you.

You could also bring the risk down in your portfolio if you wanted. As an investor, it's very difficult to not check in on your portfolio. And so of course, I'm not going to tell you not to look at it or only look at it every six months or a year. But just realize that when you do look at it, have that structure around the process and set times, whether that's every six months around end of financial year and then the calendar year, or maybe every year, that you'll go through a formal portfolio review and check all those boxes that I talked about. Look at how your required rate of return has changed. Look at your asset allocation and start with those high-level reviews before going into your portfolio and making adjustments on individual securities in there. And we'll spend some time in the next module talking through what to do about those individual securities if they're perhaps not right for you anymore. But for now, just remember that going through that formal review, going through the checklist that I just talked about is the way that we can make sure that we are not constantly churning our portfolio and making these very short-term emotional decisions that can actually get you further away from achieving your goal when what you want to do is get closer to where you want to go.