One problem that DIY investors can face is dealing with is the persistent urge to tinker with any portfolio. So, we wondered:
Are you making some common portfolio mistakes?
On that theme, common portfolio mistakes to avoid, we believe there is no perfect portfolio – just yours – which is why owning a reasonable portfolio is good enough.
Bad things can happen to good investors
We’ve all fallen into some second-guessing when it comes to money management over the years.
We wouldn’t be human if we didn’t.
We write about mistakes often enough on this site because we feel it’s important to pay it forward, share some lessons learned from others (including ourselves from time to time) and to serve as reminders about what to avoid when any financial history rhymes again.
Here are some great examples:
These are 5 big RRSP mistakes to avoid.
We encourage you to avoid these TFSA mistakes as well!
The reality is, you have the perfect investing plan until you don’t. You pick your assets, your allocation, then markets do what markets will do. They surprise us.
Over time, you notice some asset classes are doing better than others. Maybe you end up holding too much cash for too long. You realize you could have invested more when markets tanked. You kept too many higher-yielding stocks in your portfolio and forgot capital gains matters too. The list goes on…
Even though we consider ourselves very knowledgeable investors at Cashflows & Portfolios, we admit it’s tempting to change your investing plan with some shiny new investment choices now and then!
But as a reminder to us, to you, to everyone reading this site – there is no such thing as the perfect portfolio. That’s because any perfect portfolio that does exist assumes we know what the financial future holds.
Rather than trying to find the perfect portfolio we would rather develop and follow a reasonable portfolio.
Are You Making Some of These Common Portfolio Mistakes?
The inspiration for this post came from this Morningstar article:
Are you making these 5 common portfolio mistakes?
Here are those mistakes and our commentary on each of them. We encourage you to add your comments to any portfolio mistakes to watch out for below!
1. Avoid Portfolio Sprawl.
This is a great term – meaning you have too many accounts, too many holdings, with too much redundancy.
Well, sometimes the number of accounts is unavoidable.
Any couple these days is likely to have at least 5 accounts to manage, if not more, related to saving and retirement planning:
- x2 TFSAs.
- x2 RRSPs.
- x1 joint saving/chequing account to funnel money to investments.
But we get the idea…
As the article suggests, we believe indexed funds including some ETFs highlighted in the articles below are great ways for many investors to build wealth.
As Larry Bates so nicely summarized in his book Beat the Bank:
“Reject complexity. Embrace simplicity.”
Beat The Bank – Simply Successful Investing from Larry Bates
Ownership in one or more low-cost, diversified indexed ETFs can help investors by owning a world of stocks for a very low fee – keeping more of your money working for you in the wealth-building process.
Here are some of our favourite ETFs:
Then again, other forms of investing could be right for you.
2. Avoid A Redundant Individual-Stock Portfolio.
Avoid diworsification.
Coined by Peter Lynch in his book, One Up On Wall Street, this is the act of investing in too many assets with similar correlations which results in an averaging effect. It occurs when an investor adds
investments to a portfolio in such a way that the risk/return trade-off is worsened.
In more simple terms: diworsification can occur when there is impulse investing, style drift and generally favouring a particular sector over another. A huge portfolio affinity to just Canadian bank stocks could be one example.
On the flip side, a good, reasonable portfolio strategy involves an accumulation of assets with varying correlations, which reduces risk and can increase potential returns by minimizing the negative effect of any one asset on portfolio performance. A solid mix of stocks and bonds and cash could be an example.
We’ll come back to asset mix soon enough.
3. Avoid Also-Ran Mutual Funds
The Morningstar article cited being passive as an investor has merits but…
“…I’ve also observed cases when investors were too patient and hands-off: They purchased mutual funds and set up their portfolios a number of years ago and apparently never looked at or touched them again.”
We know it’s not a good exercise to be constantly changing your investment plan but that also assumes you have a process in place to monitor the performance of your assets and ensure you are meeting your long-term objectives.
The suggestion here, therefore, is that “even very hands-off investors should take a look at their portfolios once in a while to assess their overall asset allocations, make sure the savings or spending plan are on track, and yes, prune losers.”
Indeed they should.
4. Avoid Asset Allocation Not Informed By The Plan.
The mistake here is that assets may or may not meet the investor’s objectives.
From the article:
“…The most frequent example is when an individual is getting close to or in retirement yet the portfolio doesn’t contain enough safe(r) assets to address the anticipated portfolio spending. Many such investors have enjoyed wonderful gains in stocks for decades, so they’re hesitant to derisk their portfolios in favor of assets with lower return potential. (And let’s be honest, bonds didn’t make a great case for themselves in 2022′s rising-rate environment.)”
No, bonds did not!
But there are alternatives to bond ETFs in a safe-haven retirement portfolio. Here are some examples/content we have explored on this site:
Bonds vs. GICs for retirement income planning – which is better?
Should you invest in a high-interest ETF?
The Morningstar article goes on to discuss the major reason why sound asset allocation, aligned to an investor’s objectives, is important for retirement planning in particular:
to fight poor sequence of returns risk.
You see, you and I can all live with the portfolio upside, assets growing more and more over time.
It’s the market downside (of returns) we all need guard against.
Sequence risk (a series of negative, poor returns in this context) is a HUGE issue to navigate for the soon-to-retire and newly retired individual because you have a double-whammy of investor pain if not properly managed:
- You will be drawing down your portfolio when potentially markets are shifting downwards as well, and as a result,
- You will have less money and time for your portfolio to bounce back in subsequent years.
Read on for more:
In the article above, we highlighted one of our solutions for fighting a poor sequence of returns risks – implementing a bucket approach to retirement income spending.
Adopting a bucket approach is just one of many decisions to consider in your decision to retire.
5. Avoid Suboptimal Asset Location.
As My Own Advisor has frequently highlighted on his site, figuring out your asset allocation is one thing but putting assets in the right location is another. Be tax-efficient where you can.
Although that Morningstar article has a U.S. investing angle, we’ve provided some of our personal preferences below for the Canadian investor, what to put where to be more tax-savvy.
- For your TFSAs, consider owning Canadian-listed ETFs or Canadian stocks to avoid any foreign withholding taxes.
- *For your RRSPs/RRIFs, consider owning U.S.-listed ETFs or U.S. stocks to avoid any foreign withholding taxes.
*First, U.S. stocks are generally subject to 30% withholding tax on dividends for non-residents. Many countries, including Canada, have tax treaties with the U.S. to ensure a reduced rate of withholding tax. For qualifying Canadian residents, the tax can be reduced to 15%. Using your RRSP/RRIF, this tax may be reduced to 0%.
- If you have taxable investment accounts, consider Canadian dividend-paying stocks for the dividend tax credit and/or owning low-cost Canadian ETFs that pay little to no distributions – the latter to incur capital gains on your own terms which is an efficient form of taxation.
These are not things you have to do, rather, an opportunity once you get asset allocation figured out to be more tax efficient over time.
Are You Making Some of These Common Portfolio Mistakes – Summary
As you have hopefully appreciated above, while there are some common portfolio mistakes to avoid, there is by no means a set of defined rules about how you must invest, what accounts you must use, what assets you must put in those accounts and so much more…
We believe at Cashflows & Portfolios, personal finance, and portfolio management are unique and personal. Instead of agonizing over the world of investment choices out there, develop a simple plan that defines your objectives, determine your assets for that plan, and monitor that plan against your objectives over time.
We believe a reasonable portfolio can be plenty good enough.
A reasonable portfolio is one that is diversified but more importantly is designed with a very high probability to meet your long-term objectives.
Putting all your net worth into just one stock is not very reasonable.
On the other hand, keeping some cash handy while owning many stocks, from many sectors, including from many countries, is probably very reasonable including some individual stock selection as you wish.
In summary, the benefit of not being able to predict the future is we don’t have to have a perfect portfolio. Don’t let any financial advisor or money manager tell you otherwise. In fact, having a reasonable portfolio for most of us is good enough.
Need any support with any reasonable portfolio retirement income projections?
Knowing how to save and invest wisely, to help you get the most out of your portfolio, is something we can help with, including tailored support for your own reasonable retirement income plan.
As DIY investors helping other DIY investors, we’ve been more than happy to support well over 100 clients at the time of this post, in just a few short years.
We know we can help you out too at a low cost compared to services charged by others!
If you are interested in obtaining private projections for your personal financial scenario, read more about our retirement projections service.
A reminder to those who have recently joined our readership and new fans of the site – our site continues to grow thanks to you!!
As an example, a big thanks once again to Rob Carrick for mentioning our site and services in The Globe and Mail.
“TODAY’S FINANCIAL TOOL
Cashflow$ & Portfolios is the name of a website built to help people learn how to reach their long-term financial goals with budget and long-term investing. Brought to you by a pair of veteran personal finance bloggers.”
Yup, that’s us!
We appreciate every comment and email and every client interaction.
Stay tuned for more free content over time.
Mark and Joe.
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