Once the individual investments have been identified and purchased, your investment portfolio will need to be managed on an ongoing basis. Typically, this will involve three basic activities:
There are numerous approaches to monitoring an investment portfolio and the approach that you choose should fit with your portfolio’s structure, its complexity, and the amount of time and effort you can devote to the process.
As with the design of your investment portfolio you should establish guidelines or a routine to assist with the monitoring of your investments. This routine will help to ensure consistency in the management of your investments. Your guidelines should stipulate
Just as with your research efforts, monitoring your investments can be approached from a top-down or bottom-up process:
When monitoring your individual portfolio investments, your main purpose should be to monitor the investment’s financial health and then their performance within their industry. Financial performance can mean different things to different investors, but it should include the investment’s contribution to your portfolio and the issuer or company’s financial performance.
When monitoring the investment’s contribution to your portfolio, the assessment is very basic. Did the investment help you toward your financial goal? Did it pay you any dividends? Did the dividends increase or decrease during the period? Did the investment’s market value increase or decrease? Has the investment done its job within the portfolio? Are you satisfied with your selection?
When monitoring the investment issuer’s performance, you want to ask a few simple questions such as the following:
Note: The majority of these questions can be answered by reading the issuer’s press releases. Each quarter, issuers are required to announce their financial results and the details must be presented consistently according to regulatory guidelines. In most cases, this makes monitoring and analyzing an investment’s financial health fairly simple.
Members’ Note: Use Generally Accepted Accounting Principles (GAAP)
When researching and monitoring an investment it is strongly suggested that you examine data that adheres to Generally Accepted Accounting Principles (GAAP). GAAP is a set of accounting rules, procedures and guidelines developed over time that establishes a high standard for the calculation, presentation, and reporting of financial information. Financial information derived and reported according to GAAP rules is much more reliable that non-GAAP data.
In the past few years, many companies and the investment industry have begun to report non-GAAP information that is created with inconsistent and non-standardized methods. The non-GAAP information is not comparable to previously reported non-GAAP information nor is it comparable to the non-GAAP information of other issuers.
Example: Adjusted or Cash Earnings are not calculated according to GAAP. These are calculations created by the company’s management that cannot be compared to company’s prior period’s calculation of the same data and they cannot be compared with the Adjusted or Cash Earnings calculations published by a company’s competitors. Each company creates its own method for calculating non-GAAP data and the calculation can and often does change from period to period.
So if you calculate the Price to Earnings (P/E) ratio for a specific company’s stock using their Adjusted Earnings, keep in mind this ratio cannot be compared with prior period’s P/E ratio as the calculation of Adjusted Earnings may not be the same for each period. In addition, if you are comparing today’s P/E Ratio with historic P/E/ Ratios, keep in mind the historic numbers may have been calculated under GAAP and thereby give an inaccurate comparison and conclusion.
Remember: When monitoring an individual investment’s financial health, there are a number of items to look out for:
When rebalancing a portfolio, we are making a decision to sell all or a portion of a successful investment and to use the proceeds to buy another investment. Typically, we are selling an investment that is in one specific asset category and buying an investment in another asset category.
Example: We may be selling all or a portion of a Growth investment and using the proceeds to buy a Fixed Income investment, or vice versa. Typically, re-balancing does not involve selling and buying investments within the same asset category. Selling and buying investments within the same asset category would be considered an Adjusting transaction and is discussed below.
As mentioned when re-balancing your investment portfolio, you are typically selling a successful investment and buying a less successful investment. The investment has either been successful by
Most often when we think about re-balancing a portfolio, we envision investment success. One of our investment categories has achieved or exceeded our goals and as a result our portfolio’s actual asset allocation is out of line with our Targeted Asset Allocation. As a result, we must sell a portion of the successful asset category and buy additional investments in the less successful asset category. This type of re-balancing is done to preserve the profit made from the successful investments by selling Growth investments and buying Fixed Income investments.
Note: Target Asset Allocation refers to your investment portfolio’s optimal asset allocation as defined in your written Investment Policy Statement (IPS). For example, if your IPS states that your asset allocation should be 65% invested in Fixed Income investments and 35% invested in Growth investments, then your Target Asset Allocation would be the 65%/35% allocation. Your Tactical Asset Allocation is used as a reference guide when reviewing and re-balancing your investment portfolio.
This can be a difficult decision – difficult because you will more often than not be selling an investment that everyone says you should be buying, and you will be buying an investment that most say you should not. This feeds your innate fear of making a dumb decision. But you are not making the decision to win friends or bragging rights. You are making the re-balancing decision because it fits within the guidelines set out in your IPS, which has been designed to help your savings achieve your financial goals.
The opposite side of the re-balancing coin dictates that you should also be re-balancing by selling a successful investments and buying weak or unsuccessful investments. This type of re-balancing involves selling investments in an asset category that has maintained their value and buying investments that have declined in value. This type of re-balancing is done to maintain your portfolio’s Target Asset Allocation and to maintain the guidelines set out in your IPS.
This type of re-balancing often involves selling Fixed Income investments and buying Growth investments at a time when Growth investments are out of favour and declining in value. Re-balancing in this investment environment is extremely difficult. You are selling a safe, steady Fixed Income investment and buying a losing Growth investment at a time when everyone is telling you to do the opposite.
Note: Establishing the guidelines and criteria for re-balancing an investment portfolio is easy. Finding the discipline to consistently adhere to those guidelines is where most investors fail. Having the courage and confidence to follow your IPS and make the sell and buy decisions, as required, is extremely difficult. If you do not have the discipline and conviction to adhere to the 12-step process that proper portfolio design entails, then you best not waste your time and energy.
Remember: Investing involves designing and managing a portfolio during both the good and the bad investment cycles.
As we have discussed, no one can foretell the future of investments. As investors, all we can do is
But in addition to all of the above, we must also remain open to changes and events that are beyond our control. We must remain flexible enough to
Change within the investment world is inevitable and constant. Investment options change, investment services evolve, technology changes, economies move quickly and slowly through the different cycles and our own personal circumstances often change.
Investing for your family ten years down the road will be different from today. Your family’s financial and personal circumstances may be different. Your investment knowledge and experience will be different. You must always remain open to change and be prepared to adapt accordingly. With this in mind, your investment approach must remain open to changing circumstances.
Maybe at some future date, your financial circumstances change. Maybe they improve or maybe your fiancé’s deteriorate. You must be prepared to adapt your investment approach and guidelines accordingly. Your change in circumstances may be temporary or they may be more permanent and you need to first determine which, and then act accordingly:
In addition to changes in your family’s circumstances, changes to individual investments may also result from changing investments circumstances. Adjusting the portfolio’s individual investments may be driven by negative or positive events. For example, in October 2006 the Canadian federal government announced a change to the income tax treatment for the Income Trust units. Such a change as this may alter your decision to continue buying and holding this type of investment, and so you would need to revise your IPS and investment guidelines to properly reflect such a change.
Changes due to technological discoveries, inventions, or improvements might also create investment opportunities that did not previously exist. A new business or an old business may evolve into a great new investment opportunity, or maybe simply the investment cycle may change and prompt you to position your investment portfolio for that change.
An individual investment may also not be performing as you had expected. Maybe the company is losing sales to a competitor, a new technology, or consumer trends. Maybe the investment’s income payments have declined or maybe there is simply a better investment within that particular industry or sector. As a result, again you may need to adjust your portfolio’s individual investments.
Changes in a portfolio’s individual investments to take advantage of new opportunities are often referred to as tactical changes. Tactical changes are made to try and take advantage of opportunities when they arise.
Many investors refer to specific guidelines for tactical investments within their IPS. By doing so, the portfolio can establish dollar amounts and specific investment criteria to guide the tactical investment decisions.
Example: An IPS might state that a certain dollar amount of the portfolio be
Each of these allocations would be classified as tactical allocations. These types of adjustments to individual investments are made to take advantage of opportunities should they arise. The allocated funds can be invested or held as a cash balance until they are needed.
Remember: Monitoring, re-balancing, and adjusting your portfolio’s investments is an ongoing activity. Because the future is unknowable, the best investors can do is
Remember: To be successful, you need to invest time and effort. Investing success does not happen all by itself.
Now you are ready to move on to Step 12: Measure and Monitor the portfolio’s actual annual rate of return.