How often should you review your investments and consider whether you need to make alterations?
Once a year, or when your circumstances change, i.e. you have quintuplets or you lose both your legs in a lion-taming accident. Fiddling with it any more frequently than that will probably be a waste of time and effort, and might be counterproductive. A watched pot and all that. Feel free to examine your investments frequently, but if you change them more than once or twice a year, you’re playing with them. Hands off!
Investments work best if they are long-term and you don’t chop and change them too frequently, especially your growth assets. Only modify your plan if you have a really good reason to do so.
Good Reasons to Change Your Investments
1. To rebalance. This is a fancy word but the concept is easy enough to understand. Let’s look at an example:
If your asset allocation strategy is to hold 20% in bonds and 80% in shares, you might sometimes find that the stock market has had such a good year that your shares have grown to 90% of your total investments, with your bonds now languishing back at 10%.
Assuming your plan is unchanged, you need to move some money from the share fund over to the bond fund until they’re back at your intended 80/20 split. This is called ‘rebalancing’.
Here’s another example, to make sure you’ve got it. Let’s say you have the same 80/20 split but the opposite happens – there’s a stock market crash. When it comes time to review your investments, you find that your shares are now down to 60% of your investments, while your bonds are up to 40%. How do you rebalance? That’s right, you move some of your money from bonds into shares until you get back to your original 80/20 split. It is that simple.
If you’re with Vanguard, download the ‘change of investments form’ on their website, fill it out, and send it in via mail or fax. In some countries you may be able to do it all online. It depends on local regulations. In any case, it’s a once-a-year, fifteen minute job.
Please note that diversified funds which hold both shares and bonds, like the Vanguard balanced funds mentioned a while back, will do this for you automatically. For example, if your diversified fund holds 80% shares and 20% bonds, and shares shoot up, the fund will automatically rebalance so that your investment will remain at its planned 80/20 split. If you hold this type of fund, you don’t need to rebalance yourself. Continue to review your investments yearly to see how things are going.
It is tempting here to think, hey! Shares are going great! Why on Earth would I want to move money out of there?
This is a classic rookie error. Just because the market did well last year doesn’t mean it will necessarily do well this year. Don’t try to read the future in a crystal ball because you don’t have one. Stick to the plan. Remember, don’t chase past performance because it is not necessarily an indicator of future performance.
In fact, if shares have shot up over the last year, that is a good time to sell a few while they’re high and pick up some more bonds. If shares have declined, it is a good time to buy more by moving money over from your bonds, because the shares are cheap. No brainpower is required here, no timing, and no grand strategy: rebalance annually (or so) and it will all happen for you, as if by magic.
If you have chosen a 100% shares investment strategy for now, there’s no need to rebalance. As you get older and near retirement, you will need to take on some defensive assets and that’s when you’ll start to rebalance annually.
Before we continue, a reminder: we were listing good reasons to change your investments during your yearly review. Let’s look at the next one:
2. Your risk profile has changed. For example, if you’ve been tossing and turning in your bed worrying about a stock market crash, consider decreasing the percentage of your wealth in shares and increasing the amount in bonds and cash. Or if you’re suddenly thinking that you’re happy to take on more risk, do the opposite. Don’t make such a change on a whim. Think it through carefully. You don’t want to be switching back and forth all the time according to your shifting mood – pick a plan and stick with it.
3. You might change your investments if your goals have changed. For example, if you’ve fallen in love, gotten married and knocked up your wife (hopefully in that order), then you might be looking at saving for a deposit on a home. This will obviously mean reconsidering your investments, i.e. setting up a new CD/term deposit for some of your savings. Life will change, and your investments must change with it.
4. If there’s something wrong with an asset that you hold, i.e. you realize the fees are too high, or an index fund is not following the market as it is supposed to, or if you picked your own stocks like I told you not to and a company you bought has been caught out in a nasty scandal, those are all good reasons for changing your investments.
5. If the investment itself has changed. For example, I noticed recently that a diversified fund offered by my superannuation company had changed from a growth to a primarily defensive strategy. If you were aiming for growth, it would be reasonable to switch in that situation.
On another occasion I noticed that a high-interest bank account’s interest rate had sunk from around 6% to 3%. In a third case, I saw that property had been dropped from a diversified index fund.
Check up on all your investments yearly and see if they are still doing what you think they are doing. Read over investment strategies and fees. Every now and then you’ll find that something is no longer suitable.
6. Finally, if a good financial advisor gives you sensible advice about changing your investments, you might as well pay attention. Because why else are you paying him?
If you make any major changes (i.e. not just normal rebalancing), get advice and consider shifting your investments gradually rather than all at once.
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