4/22/2014 2:45 PM ET|
Spring cleaning? Toss these investments
Rebalancing your retirement portfolio is more crucial than ever this year.
A well-tuned portfolio requires regular maintenance. And while some people have the discipline to tinker with their portfolio around the first of the year, the crunch of the holiday season tends to get in the way for some of us.
That's why I like to do my rebalancing and portfolio review in the spring, along with tax preparation.
Some years there isn't much to change, but after a 30 percent run for stocks last year and the recent volatility brought on by unrest in Ukraine and the tapering of quantitative easing by the Federal Reserve, there are plenty of items on my to-do list.
Sell some momentum plays
There have been a number of high-profile momentum investments that have rolled over in the past few months. And if you're lucky enough to still be sitting on mammoth gains after a selloff due to an attractive cost basis, good for you . . . but don't get complacent.
I always advise protecting profits in the highest fliers by selling a partial stake. For starters, a stock that goes up by double (or triple or quadruple) sometimes becomes an outsized portion of your portfolio, and rebalancing is an important way to keep the right asset allocation and diversification.
And, of course, selling a partial stake locks in those profits while they're there. You will still have a small foothold in the investment to participate in further upside, but you won't run the risk of watching your portfolio take a big hit should the momentum end in a painful decline.
Take a look at some momentum stocks that have recently hit a wall:
- 3D Systems (DDD) is still up about 70 percent in the past year and 230 percent since spring 2012 but has shed over 40 percent in 2014 after the 3D-printing stock warned on profits a few months back.
- Best Buy (BBY) was trading in the low $11s at the end of 2012 and is now over $27. Best Buy has fallen over 30 percent this year, however, after horrific holiday sales caused investors to start doubting the retailer's turnaround.
- Biotech standout Gilead Sciences (GILD) has tripled since early 2012 even after a 16 percent drop in just a few weeks.
I'm not going to use the "B" word for any of the flameouts we've seen over the past few month. However, it's important to remember that big outperformance can't last forever, and it's sometimes prudent to sell some of your shares while you're still sitting firmly in the black.
Trim bond funds
The Federal Reserve cut back on its bond buying for the third consecutive meeting, and Chairman Janet Yellen has telegraphed to investors that interest rates are likely to rise in spring 2015, assuming the economy continues to improve.
It's not so much a question of "if" tighter central bank policy will hit, but when.
That means investors should start preparing their portfolio for changes coming in the next year or two. When rates rise, the price of bonds goes down. It's simple supply and demand, because investors can get better yields on current debt and so older bonds with lower yields are less attractive.
Since most bond funds don't hold their investments to maturity, investors with big bond fund investments could face substantial losses in principal as a result of rising rates. Consider that from May 2013 to early July 2013, rates on the 10-year T-note rose about 1 percent and the popular iShares 20+ Year Treasury Bond ETF (TLT) lost about 15 percent of its value.
Now, that doesn't mean you should abandon bonds altogether. If you are an income-focused investor who relies on your bond funds, it's important to ensure you have a low-risk strategy that provides cash flow. Also, if you hold individual bonds to maturity, the principle declines aren't important since your monthly payments will remain fixed as long as the issuer doesn't default on its debt.
But if you have a large portion of your portfolio in long-term bond funds, it's important to at least acknowledge the interest rate risk and consider alternatives. One option is to invest in shorter-term bond funds; these often don't offer the same yields, but won't be as hard hit by rising rates.
Another alternative is to consider moving a bigger portion of your portfolio into "bond-like stocks" such as utilities, including Exelon (EXC), or consumer-staples stocks, such as Coca-Cola (KO), which offer a long history of dividends and stability. There's obviously more risk to stocks than bonds, however, so keep that in mind.
While thinking ahead to where the market may be moving is a good idea, a focus on costs is sometimes just as important to the overall health of your portfolio. Here's some simple math to illustrate:
- $100,000 invested at a 5 percent annual rate of return for 25 years will result in a final nest egg just shy of $340,000
- $100,000 invested at a 6 percent return for 25 years will leave you with almost $430,000 -- $90,000 more.
The power of compound interest means reducing your cost basis by a few percentage points can unlock significantly more value over the long haul.
It's tempting to chase performance, but active management doesn't usually provide better results -- only higher costs. So why not cut costs along the way to hang on to more of your returns rather than enrich your broker or fund manager?
Speaking of which, review your broker fees and see if there's a cheaper way to trade. Also, given the continued growth of the ETF industry, there could be cheaper alternatives to some of the funds in your portfolio that offer similar strategies and performance.
You shouldn't change your asset allocation or retirement strategy based on cost alone. But if you can get the same results for smaller fees, why wouldn't you?
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