Guidance

RESOURCES TO HELP SHAPE YOUR FINANCIAL FUTURE

Decluttering is hot.

The Life-Changing Magic of Tidying Up: The Japanese Art of Decluttering and Organizing has been perched near the top of best-sellers’ lists since it was released last year, and author Marie Kondo is a celebrity in her native Japan. A search for books related to “decluttering” on Amazon.com yields more than 1,100 results.

Decluttering enthusiasts say that getting organized and making do with less stuff helps them think clearly and frees them up to focus on what is really important.

Many of those same virtues can be extended to decluttering a portfolio. With fewer moving parts to oversee, it is easier to focus on the truly important aspects of your portfolio plan. Are you on track to reach your goals, whether a comfortable retirement or a home down payment? Is your asset allocation sane, given your life stage?

Like decluttering your home, reducing the number of odds and ends in your portfolio has the salutary effect of making life easier for those who have to manage your affairs when you can no longer do so yourself.

Put Your Holdings to the Test
Of course, decluttering is more art than science, whether you are getting rid of stuff in your coat closet or your portfolio.

Kondo’s criterion is that each possession you hang on to must “spark joy,” which is a bit squishy. Perhaps more straightforward and practical is the test home-declutterers have long been advised to employ when deciding what to keep and what to toss: Is it useful? Is it beautiful? An item gets bonus points if it is both, but it goes into the pile for Goodwill if it is neither. A parka? Not beautiful, but useful during winter. It stays.

In a similar vein, portfolio-declutterers can put each of their portfolio holdings to a straightforward test. Beauty is not a consideration with investments, but usefulness certainly is. Thus, it is reasonable to assess each of your holdings’ utility value. Have they delivered on key investment goals, whether growth, income, or stability? Or better yet, have they delivered on more than one of these goals?

Armed with an assessment of how well your holdings have performed the jobs you hired them to do, you can then start to determine what to keep and what to give the heave-ho. Of course, there may be mitigating factors—a holding in your portfolio may not have done much for you lately, but you like its bottom-up attributes. But the simple “jobs” test can help you determine which holdings merit further scrutiny, and possibly dismissal from your portfolio.

Getting the Job Done
To get started with decluttering your own portfolio, start by tagging each of your holdings with your goal (or goals) for them. What basic investment functions do you expect them to fulfill?

There are three main goals that investments can serve: growth, income, and stability. (Investments may also help to diversify a total portfolio—and, thus, improve that portfolio’s risk/reward profile—but you would hope that they would also deliver at least some growth, income, or stability along the way.)

Most investors look to their holdings to provide more than one of these basic attributes. For example, you might hold dividend-paying equities for a combination of current income and growth, as well as to be less volatile than your other equity holdings. You own bonds, meanwhile, to help lend stability to your portfolio; you probably also look to them to provide income.

Once you have articulated what you are expecting your holdings to do, you can then size up how well they have delivered. However, narrow peer groups can make it easy to get lost in the weeds, and short-term performance can be noisy. Here are some simple tests for determining how well your holdings have done their jobs over long periods of time.

Growth: If you are holding an investment for its long-term growth potential, it is reasonable to use the long-term performance of a total-market equity index fund when benchmarking how well it has delivered. Total U.S. market index funds have returned about 15% during the past five years and 8% during the past 10. Total international funds’ returns have been less impressive—about 5% during the past five- and 10-year periods.

Equity holdings should not automatically go on the chopping block if they do not beat those simple benchmarks. It could be that they look absolutely nothing like those benchmarks, or the trailing time periods cast them in a bad light yet they have earned their keep in other environments. But you will want to make sure they have delivered on another goal—either income, stability, or diversification—to merit a continuing slot in your portfolio.

Income: If you are holding equities at least in part for their income production, a payout that is higher than the S&P 500’s—currently just under 2%—is a reasonable (and surprisingly competitive) starting point. Good-quality dividend-yield-oriented funds have yields of about 3%, currently.

Setting an income hurdle is trickier for bond investments, as a bond fund’s yield will tend to be inversely related to how much stability it provides. You may be able to find a yield north of 3% from a fund that delves into lower-quality or otherwise higher-risk bond funds, but you will sacrifice on the stability front. If you are aiming for a fund that balances yield with stability, it is reasonable to expect a minimum yield of 2%—the current yield of funds that track the Barclays U.S. Aggregate Bond Index. You will want to hold short-term high-quality bond funds to a lower standard, but a yield north of 1% is reasonable today. Those are low numbers, of course, but you will likely see improvement on this front when interest rates begin to head up.

Stability: If you are holding an investment to stabilize the more-risky portions of your portfolio, you can go straight to a simple gut check. How did it do in 2008? If you are holding bonds to stabilize your total portfolio, you will want to see small losses—or even gains—in that year. Equities, of course, lost substantially more than that in that year. But if you are holding equities because you expect them to hold up better than the broad stock market in a downturn, it is reasonable to look for losses of less (preferably much less) than 30%.

Standard deviation is another way to gauge an investment’s stability (or lack thereof). For bond holdings, a 10-year standard deviation of 3.5 or lower is a reasonable threshold for assessing stability. Lower-risk equity funds, meanwhile, have posted 10-year standard deviations of less than 15. That is not to say you should not hold investments whose volatility levels exceed those thresholds, but rather that stability should not be a key reason for owning them.

 

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