You've learned from your own investing errors. Now, let's see what the mistakes of others can teach you.
Our laboratory is The Globe and Mail's online video series Portfolio Checkup where I team up with an investment adviser to offer feedback on portfolios submitted by Globe readers.
If you're selected for Portfolio Checkup, we look at your investments and assess how well they match up with your needs as you describe them to us. Overall, the portfolios we've seen aren't bad at all. But there are a few recurring errors worth highlighting:
1. Flaky stock picks
This happens often in preparing for Portfolio Checkup: In the midst of a basically good mix of blue-chip stocks, mutual funds or exchange-traded funds, I'll find a speculative stock or three. Often, it's a junior gold or energy stock. Research In Motion crops up, too.
The bright side of tossing a stock pick or two into an otherwise well-built portfolio is that the potential for serious damage is limited. But it's evident that many picks are based on just guesswork. They're often money losers with no dividend to take the edge off a declining share price.
We've seen just one portfolio that was built in large part with speculative stocks. The person who owned it absorbed our feedback, dumped the portfolio and is now investing in a good low-cost family of mutual funds. Watch for the full story in an upcoming segment of Portfolio Checkup called Taming The Risk Monster (see chart for more details).
2. Holding onto losers
A portfolio I looked at recently had some Nortel shares with a book value of $4,447 and market value of 20 cents (Nortel is listed on the U.S. over-the-counter market under the symbol NRTLQ). Another portfolio had some E*Trade Financial shares with a book value close to $6,000 and a market value of a little less than $850.
We get asked by Portfolio Checkup candidates whether stocks like these should be sold. The answer: Unquestionably and unambiguously, yes. Flushing away your bad stock picks will make you feel great and help you move forward to more productive investments.
Every investor blows it now and again. What separates the smart ones from the others is how quickly they recognize the mistake, sell it to limit losses and move on.
3. Too little in bonds
We've heard a million times about how investors missed the stock market runup of the past year or so because they were so focused on bonds. I don't see that in the accounts reviewed for Portfolio Checkup. In fact, many of the portfolios, perhaps even a slight majority, are too skewed to the stock market.
One submission was sent in recently by a fifty-something business owner; his seven-figure portfolio was intended to act as a retirement fund. Guaranteed investment certificates, a perfectly good bond substitute, accounted for all of about 2 per cent of the portfolio. Add cash holdings and you're up to about 9 per cent. The rest were equities.
Bonds have more room to fall than rise if you look ahead a year or two, but they're still essential as a cushion if the stock markets decline. Only ignore bonds if you think this just can't happen.
4. Fuzzy thinking on bonds
I get the sense in looking at portfolio that people agonize in choosing stocks for their portfolio. The bond side? I'm guessing about three minutes' worth of research is not uncommon, and this applies both to self-directed and advised portfolios.
One Portfolio Checkup applicant's adviser took the risky approach of basing almost all bond exposure on a single bond issued by a real estate investment trust, or REIT. Another portfolio used high-yield bonds almost exclusively. They offer among the best returns in the bond market right now, but the risk profile is not much less than stocks.
Don't neglect the diversification of your bonds. Own some government and corporate bonds (GICs are great, too) and maybe a bit of high-yield. My experience with Portfolio Checkup suggests investors who use exchange-traded funds do the best job of ensuring they have bond exposure that is sensible both in quantity and quality.
5. Missteps with cash
One young man who came to Portfolio Checkup had a cash weighting of 38 per cent. A senior with a large portfolio and high expectations for generating retirement income was close to 50 per cent in cash. Use cash for money you refuse to lose, and as a temporary parking place. As a major portfolio component, it's close to dead money.
That's especially true for the many investors coming into Portfolio Checkup with cash just sitting in their investment accounts. A few are using high-interest savings accounts that trade like mutual funds, but not enough. These accounts pay 1.25 per cent and they're offered by such firms as RBC, Dundee Bank, Manulife Financial and Renaissance Investments.
6. Haphazard mixing of stocks with ETFs and mutual funds
Stocks or funds – pick one. When you mix them, you run the risk of getting more exposure to certain stocks than you might want or need. Consider an investor who came to Portfolio Checkup with four separate accounts, three of which included bank common and preferred shares.
Other holdings were a Canadian equity mutual fund and exchange-traded fund, where bank stocks were also major holdings. In fact, four of the ETF's top six holdings were banks. Financial stocks make up about one-third of the S&P/TSX composite index – if anything, you want to reduce that dominance when arranging a portfolio.
I've also seen a few cases of investors mis-matching U.S. stocks and ETFs. They buy an S&P 500 ETF or index fund and then add stocks such as Johnson & Johnson, Pfizer and Procter & Gamble. Each of these three companies is a Top 10 holding in the S&P 500.
Cut The Risk
Here are two portfolios owned by an investor who sought a second opinion from The Globe and Mail's Portfolio Checkup online video series. The first is the original portfolio, which we found to be too risky and undiversified as a result of its inclusion of many speculative stocks.
After watching our assessment, this investor interviewed several advisers and settled on one who created the second portfolio. It's based on funds in the low-cost Dimensional Fund Advisors family.
1-yr % rtn
Alpha Natural Resources
Bank of America
Home Capital Group
West Fraser Timber
Fidelity Canadian Large Cap
DFS Fiersa Sceptre Canadian Small Cap
Jarislowsky Select Canadian Equity
1-yr % rtn
Dimensional Fund Advisors 5 Year Global Fixed Income
DFA Canadian Core Equity
DFA U.S. Core Equity
DFA International Core Equity
DFA Global Equity
DFA Global Real Estate
One-year percentage returns for stocks are as of Feb. 6, for mutual funds as of Dec. 31.
Get a second opinion
We're looking for all types of investors for our online video series Portfolio Checkup, from beginners just starting with RRSPs and TFSAs to people who have spent decades managing their money. We welcome do-it-yourselfers, and clients with advisers. If you're chosen, we'll discuss your portfolio discreetly and anonymously. Apply here: Does your portfolio need a checkup?