Five common portfolio flaws

COMMENT

During the past couple of years, our company has done hundreds of independent portfolio reviews. Customers seem to like that we have nothing to sell and we do not manage money, so we can really tell them the straight goods.

If we think their portfolio setup is horrible ( and some are), we let them know, and we don’t need to protect a client relationship in order to keep an account, like a broker might have to do.

But we have noticed a few mistakes often pop up in these portfolios, so, at the risk of losing some future business by revealing our secrets, here are five of the most common.

1. Too many high- cost products

This is not surprising, considering most investors have a financial adviser relationship of some kind.

A client might continue to hold a very high-cost mutual fund, or a closed- end fund that once sounded really attractive. Many larger- portfolio clients own hedging products that are neither cheap nor hedge very well. Many others own stocks because they’re on a brokerage- recommend list, even though not all of these securities are good ones.

Then we have the initial public offerings ( IPOs) that sounded good at the time, but turned out not to be. We remind clients that everything sounds good in an IPO since all documents related to it are effectively just sales presentations to get the deal done.

2. Too many securities, period

The average portfolio has around 60 different securities, which is just too many. Some have hundreds. If diversification is done properly, an investor needs no more than 20 to 25 positions.

The main reason behind having too many securities is that investors do not like selling their losers. They continue to hang on to stocks long after the game is over.

Sometimes we will examine a $ 10- million portfolio and find 15 tiny moneylosing companies with a combined market value of $ 30,000. Even if one or two of them doubles or triples, it will mean very little to the total value of the account.

We’ve seen growth investors loaded up with dozens of preferred shares, and income investors who have dozens of risky micro-cap stocks. We don’t ask, but most of these are likely bought on tips or rumours with very little homework done. Investors sometimes just need a third party to ask why they are still holding such losers.

3. Incorrect sector allocation

There are two main issues here. First, Canadian investors simply love their bank stocks. Sure, they have performed well, but some portfolios have a financial sector exposure ( including mutual fund positions) of 65 per cent. That is not a portfolio: it is a bet on a sector.

Similarly, most Canadian investors follow the TSX Composite index, which is massively skewed towards energy, materials and financials.

We would rather clients have a more balanced sector allocation. It doesn’t matter a hoot if you beat the TSX. Remember: you can’t spend an index.

4. Too much money

Worrying continues to be one of investors’ main hobbies, particularly worrying about how much money they will have in retirement.

Regardless of assets — and we’ve seen portfolios worth $15 million or more — investors always — always — seem concerned about whether they will have enough for retirement.

Often, our advice goes like this: Spend more money.

Many clients generate far more investment income than they can spend. Unless they go out and buy a moneysucking yacht or business jet, they can spend just about whatever they want.

Maybe they don’t want to spend it, but they should at least stop worrying.

5. Not utilizing tax benefits

This has some correlation to the second point above. Because investors keep their losing positions far too long, it hurts them in two ways: They continue to see a decline in their investment and they give up valuable tax benefits by not crystallizing their tax losses.

When we point out that taking a tax loss ( against a gain) can give them up to a 23-per-cent return (from tax savings, depending on your tax rate), they see the light.

Rather than hoping a loser stock will recover (hope is never a good strategy), they can execute a plan to sell their losers, reduce their tax burden and clean up their portfolio all at the same time.

But tax planning also means utilizing your TFSA ( first) and then maximizing your RRSP. It’s surprising how many investors ignore these tax-saving accounts.

We bet if you look at your portfolio, you will have some of these problems. Hopefully, by eliminating some of them your portfolio will prosper, and you can focus one day on the fourth point — having too much money.