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Tracking Your Asset Allocation Across Multiple Accounts

Recently we introduced The Money Management Tool to help clients better organize their financial lives. The tool has lots of features and we will occasional explain how some of the features are being used by our clients (or should be used) to help them reach their financial goals.

This post will deal with a prospective client who has many accounts and struggles to keep track of how they are invested.

Situation: A prospective client couple approached us looking for help managing his investments. They had multiple investment accounts held at different institutions. And in most cases, the accounts could not be moved or consolidated.

Problem: They struggled to understand what they really owned. They thought they were diversified by owning several different funds, but in reality they owned many passive index funds that tracked the same index. Even though the fund names were different, the underlying investments were all very similar.

Solution: The Money Management Tool could be used to connect all the accounts together. After establishing the connections between the tool and their accounts, they would be able to see a total asset allocation across all their account. We were then able to work with them to adjust their allocation.

asset allocation

The Myth of Putting All Your Eggs in One Basket

We’ve all heard not to put all our eggs in one basket when it comes to investing. Most of us would agree that sure, it’s good to have diversification but it seems like this concept of diversification has become misunderstood.

When someone says to me “I don’t want all my eggs in one basket,” they are saying they want to spread their risks out. An investor that invests only in the US stock market is putting all of his eggs in one basket. An investor who invests only in bonds is putting all of her eggs in one basket. They aren’t diversifying their portfolio and as a result are taking on risk.

Some investors make a mistake and think they are diversifying their investments, but in reality the opposite is more likely. Here are a few examples to consider:

Common Problems of Improper “Diversification”

  1. Multitude of Accounts: If an investor has a lot of different assets in different accounts it may be hard to track them all. They receive multiple statements in the mail and have to navigate different custodians when they need to make changes. It could cause confusion particularly around tax time. It becomes an administrative issue.
  2. Tax Impact: Having multiple accounts may cloud one’s view of tax consequences. They could be dealing with gains and losses in different accounts. If not coordinated, an investor could be paying more in taxes than needed. We refer to this as a tax loss harvesting strategy, where we sell investments at a loss to offset ones we’ve sold for a gain.
  3. Similar Underlying Investments: A common situation occurs when an investor has multiple mutual funds from different fund companies, thinking they are diversified. But in reality, those funds may own the same or similar underlying investments. The investor may be putting all their eggs in one basket and not even realize it. Similarly, we see investors who own utility stocks and income oriented mutual funds. When we dig into the holdings of the mutual fund, we aren’t surprised to see it comprised of utility stocks, as well. Again, the investor is putting a lot of their eggs in one basket.
  4. IRA RMD: Required Minimum Distribution (RMD) can be a massive headache if you haven’t consolidated your IRAs or 401(k)s. Missing an RMD (or not taking it out) can result in a 50% penalty.

Get Rid of Unintended Risks

As we’ve seen, the myth of diversifying assets can be misleading. It’s important to understand the true implication of diversification. Knowing how to invest properly by getting rid of unintended risks and allocating your retirement portfolio can give investors peace of mind and confidence in this present economy.

Do You Have an Out-of-Whack Portfolio?

Research out of Investment Company Institute found that 11% of investors have not rebalanced their investments in the last five years.  As the US stock market continues its bull run, the value of US stocks represent a larger and larger portion of the portfolio.

All of a sudden, a portfolio that was balanced five years ago could be taking on more risk than you originally planned. Money Magazine states that a portfolio in 2009 invested 60% in stocks and 40% in bonds may have a current mix of 75% stocks and 25% bonds.  If you’ve not looked at your portfolio over the last few years. Now is a great time to get started.  Here is a summary of steps to take:

1)      Gather all of your statements – Investments accounts with us, accounts held elsewhere, 401(k) statements, etc. Tally up your overall asset allocation.

2)      Find what looks out of line – Does one mutual fund represent more than 25% of the portfolio? Does one stock represent more than 10% of the portfolio? Is one asset class accounting for a large portion of the portfolio?

3)      Look to rebalance – identify the appropriate asset allocation (primer found here).  You may also want to spend some time developing an asset location strategy, if we haven’t guided you already.

Why the standard 60% stock / 40% bond portfolio is in decline

By using just the two asset classes listed above, investors can put together one of the most common, all purpose allocation portfolios consisting of 60% stocks and 40% bonds. For decades, it has the recommended allocation for just about any age group. But, like the “4% withdrawal” rule of thumb, even these tried-and-true strategies may not be as relevant as they once were.

For the past few years, investors have experienced very unusual situations that have left them looking for new investment strategies and new asset allocation mixes. Three factors that have reduced the effectiveness of a 60/40 allocation are:

  • Low bond yields and low stock dividends.
  • During significant downtrends, such as the recession of 2008 and 2009, bonds and stocks both move down together (a strong correlation).
  • Volatility in the marketplace with no clear market direction.

It has even been suggested that 60/40 portfolio has 80% of the volatility of a 100% stock portfolio. That comes as a shock to many investors who thought they were more diversified than they really were.

Contact us for a free consultation to help you build your asset allocation

 

Four Popular Asset Allocation Strategies

There are four ways to determine an appropriate asset allocation.  Each one with pros and cons.

  • Rule-of-thumb formulas. These are useful for quick planning purposes.  For an investor, this should be a starting point to see if their current allocation is in the ballpark.
  • Risk Tolerance. Investors can complete questionnaires which can identify how comfortable they feel about volatility in their portfolio.  The questions identify how the investor would feel if they were to see their account value decline by X% over various time frames.  Based on their answers, a portfolio is designed around their risk profile.  This is an objective data driven solution, which many find appealing. Unfortunately, an investor’s risk profile is not static. It changes day to day, depending on life experiences, the news, and a variety of other factors.  When the economy has a negative outlook, an investor’s appetite for risk is usually much lower than when the economy is bullish.
  • Stage of Life.  Age-based asset allocations that adjust over time have grown in popularity.  The premise is simple; as an investor gets closer to retirement, their allocation shifts to more conservative asset classes.  This can help avoid periods of extreme market volatility right before entering retirement.  The downside? this approach does not factor in personal considerations such as risk tolerance, longevity or financial goals.
  • Goal based. At times, we have built portfolios around a client’s financial goal, such as having $500,000 in assets by the time they retire.  We can show the client the risk profile they would take on if they wanted to try to reach that goal.  This is often used to spark conversation with the client about other factors that should be explored, such as increasing the savings rate or lowering the goal.

Bottom line, there is no single solution on how to arrive at an appropriate asset allocation.  A combination of some or all may be appropriate.  Maybe an investor uses the Stage of Life Approach and tilts it more aggressive or conservative depending on their specific risk tolerance.

Contact us for a free consultation to help you build your asset allocation.

A Case for Emerging Market Debt

Emerging market debt has recently become a more-widely accepted asset class for income investors looking to diversify their portfolio. It consist primarily of bonds issued by countries with emerging economies (Australia, Brazil, Taiwan, China to name a few) backed by taxes.

It was not long ago, however, that this asset class was basically off limits, frowned upon, or just impossible to access. And there wasn’t much demand, either, since this had been a volatile asset class. But as demand for this asset class has increased, so have the number of investment vehicles that can access it.

In the 1990’s and early 2000’s, many emerging economies experienced a significant fiscal crisis, similar to what the U.S., Europe, Japan and several other developed countries are experiencing today. These emerging economies have rebuilt their fiscal houses and are much further down the road to recovery than many developed countries.

With their fiscal issues “solved”, they are now reaping the benefits. Their credit rating is improving. Once, thought of as default prone, they are becoming much more stable. There are a few standout results, such as Russia which went from a C rating to BBB+ in about two decades. South Korea went from BB to AA- in the same time frame. And now, the average for all emerging market debt is almost BBB+.

Specifically, the issues they “solved” that resulted in higher credit rating can be summarized:

1) Emerging economies have reduced spending and are more fiscally prudent than before.

2) With spending limited, more funding can be directed to pay down debts which improves their balance sheets and debt ratios.

3) Long term issues have been addressed. The Social Security debate we are having in the U.S. was addressed years ago in emerging markets. Their solution: compulsory self-funded private retirement system. This clarity means it will be more likely for developing countries to pay down other debt.

4) A more stable local currency and better access for investors has opened them up to foreign investment.